Oaktree Specialty Lending Corporation
Q2 2009 Earnings Call Transcript

Published: 8 May 2009

[Operator:]

Good day everyone and welcome to the Fifth Street Finance Corp. second quarter 2009 earnings conference call. Today’s call is being recorded. At this time I’d like to turn the conference over to William Craig, please go ahead sir.

[William Craig:]

Thank you, Melissa. Good morning and welcome everyone. This is the conference call to discuss the results for Fifth Street Finance Corp. for the second fiscal quarter ended March 31, 2009. I have with me this morning Len Tannenbaum, CEO and President; Stacey Thorne, VP of Investor Relations; and Bernard Berman, Chief Compliance Officer, Executive VP and Secretary. Before I begin I would like to point out that this call is being recorded. Replay information is included in our press release today and is posted on our website. Please note that this call is the property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call of any form is strictly prohibited. I would like to also call your attention to the customary Safe Harbor disclosure in our press release today regarding forward-looking information. Today’s conference call includes forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that would cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements, unless required by law. To obtain copies of our latest SEC filings, please visit our website or call Investor Relations at 914-286-6811. The format for today’s call is as follows; Len will provide an overview; I will summarize the financials and then we will open up the line for Q-and-A. With that, I’ll turn it over to Len.

[Len Tannenbaum:]

Thanks Bill. I’m pleased to report that from Fifth Street’s perspective, the macroeconomic environment continues to improve. It is nice to operate without a headwind of the deepening recession, but we have yet to feel the wind at our back. Though, we did experience a slight increase in NAV for the quarter, we were able to add to our unrealized write-down basket. I view this basket as a loss reserve. Our basket of unrealized write-downs, taken on both an economic and yield adjusted basis should be sufficient to account for the foreseeable losses that we will incur from this economic cycle. This will happen as long as the stabilization of the economy continues. Our board had reduced the dividend from $0.33 to $0.25 for our fiscal year third quarter due to charge-offs in our portfolio. We also targeted the lower end of the 90% to 100% payout range to allow for future charge-offs if necessary. Given limited additional charge-offs, I would expect that the dividend should increase by the end of the calendar year. We believe the dividend should be paid out of earnings, net of losses. Obviously, visibility on higher earnings from leverage or better performance should increase the dividend going forward. We are conservatively leveraged. We only have about $14 million of leverage currently drawn on our $50 million BMO facility. This is very little leverage on the $270 plus million equity base. We continue to pursue additional leverage, but we only feel comfortable taking on this additional leverage if we do not have a duration mismatch. Our average loan is repaid after 2.5 to 3 years. We believe, we should properly match our borrowings to our assets and therefore a 3 year credit facility would be preferred. The SBA where we continue to be in the process to obtain a license, would obviously provide a long term source of capital should we receive a license. We hope to provide more clarity as to where we are in the SBA process in the future monthly news letter. In addition we are working with our lending partners to develop a larger, longer term solution for additional capital. Another sign of positive progress in the economy at least from our perspective is that several of our companies are finding ways through refinance us out of our loans. A significant portfolio holding is currently exploring strategic options with a reputable investment bank. Elephant & Castle is also pursuing a refinancing solution for part of their debt. As these are both second lien securities, these exits would allow us to continue our shift to financing primarily first lien securities. We currently have 46% of the portfolio in first lien securities at fair value and expect that ratio to continue to increase. This environment in which many of our competitors are being forced to deleverage or evaluate the market entirely, continues to create great lending opportunities with the best risk adjusted returns we have ever seen. We are excited to be one of the few firms that will continue to deploy capital in this environment Over 85% of our capital has been deployed since July 2007, when the credit dislocation began. We look forward to continuing to execute on our business plan and delivering results. I am pleased with our progress at navigating through these difficult times and have growing optimism about our prospects going forward. With that I’ll turn it back over to Bill.

[William Craig:]

Thanks Len. With respect to our balance sheet ending March 31, 2009, total assets were $297.6 million, which included investments of $290.8 million at fair value and cash of $3.7 million. Debt was at $21 million and stockholder equity was $272.4 million, but as Len mentioned, as of May 4, 2009 we had $14 million of borrowings outstanding under our credit facility. Our weighted average yield on investments was 16.4% at March 31, 2009 which includes a cash component of 13.4%. Our net asset value per share at March 31, 2009 was $11.94 as compared to $11.86 at 12/31/2008. I’d like to review our earnings. For the quarter, total investment income was $11.9 million and total expenses were $4.4 million, resulting in net investment income of $7.5 million. We ended with a net investment income per common share of $0.33 and earnings per common share of $0.12. With regard to the dividend, our Board approved a third fiscal quarter 2009 dividend on April 15, of $0.25 a share. The third quarter dividends will we paid on June 25, for stockholders of record of May 26. Going forward, we plan to pay a regular dividend in connection with our quarterly SEC filings. At March 31, 2009, 94% or approximately $217 million of our interest bearing investment portfolio consists of fixed rate loans and 6% or nearly $17 million consists of floating rate loans. All of our floating rate loans carry a minimum interest rate float of at least 9%, which protects our return in a low rate environment. With respect to the portfolio during the three months ending March 31, 2009, we invested $24.2 million, $22.6 million was in one new investment and $1.6 million was in two existing portfolio companies. At March 31, 2009 our portfolio consists of investments in 26 companies, all of which were completed in connection with an investment by a private equity sponsor and these investments at fair value consisted of 46% first lien loans, 53% second lien loans and the remaining 1% equity investments. As of March 31, 2009, we had stopped accruing PIK interest and OID on four investments, including two investments that had not paid their scheduled monthly cash interest payments or were otherwise on non-accrual status. With respect to our ratings in March 31, 2009 the distribution of our debt investments on the one to five rating scale at fair value was as follows

[Stacey Thorne:]

Thanks Bill. For the month, Fifth Street did not report quarterly earnings; we released a monthly news letter. If you like to be added to our mailing list and we see those communications directly, you can either call me directly at 914-286-6811 or send a request e-mail to [e-mail]. Alternatively e-mails can be sent through the shareholder tools link under the Investor Relations cap on our website, www.fifthstreetfinance.com. Thank you everyone for participating on the call. I will now turn it over to Melissa, to open the line for questions.

[Operator:]

(Operator Instructions) We’ll go first to Greg Mason with Stifel Nicolaus.

[Greg Mason:]

Good morning, everyone. First I wanted to see if you could give us a little more color on the potential expanded credit facility and SBIC facility; any expectations of timing on either of those vehicles?

[Len Tannenbaum:]

Obviously they are both very important event should we progress far enough to get them and I would like to release a press release on both of those items, if and when we do get them. I don’t think we’ve reached that point at which we feel comfortable releasing anything, but to say that both of them are moving forward is probably the right comment.

[Greg Mason:]

Okay and could you talk about, you did charge-off on CPAC and American Hardwoods. This is actually the first time I’ve seen a BDC do this. You realized a loss, but you have not exited those investments, is that correct? How are you able do that? I don’t think we’ve seen that before in the BDC space?

[Len Tannenbaum:]

What our charge-off is, is when we believe we have a very high threshold for this, that it is an uncollectible asset, we do this charge-off. Now this is not done at the end of the quarter; this is done when and if we feel that we’ve reached that high threshold in terms of uncollectibility. So it could have been done in January or February or March, in this case. When that happens, we charge-off, similar to a bank charging-off an asset; in fact very similar to it, and we will reduce distributable income by that amount, which we’ve done and basically the cost basis of that investment drops by the charge-off amount. By saying that, basically we’re replacing our worst performing assets with cash and so, effectively we’ve sold it for cash, because in the place of this $12.4 million, we over the course of a couple of quarters are going to recoup all the cash.

[Greg Mason:]

Then to stay on that topic, if your dividend stays flat at $0.25 and I believe your 2009 taxable year is actually from January to December, so then we will look at you paying roughly $1 per share dividend in 2009 tax year or about $22.6 million in dividends and then you just took this $12.4 million in realized losses that offset taxable income. So, as we kind of look at that, if you add what you expect to pay $22.6 million plus the realized loss, you got about $35 million of pre-loss kind of NOI and you said you’re targeting the bottom end of the 90% to 100% payout ratio. Is there anything else that we need to add to that or adjust that math by or is $35 million kind of a way reverse engineer, what you guys are looking for the year?

[Len Tannenbaum:]

I’m thinking of the taxable year and that’s the difference. It’s an October to September taxable year, so the distribution cycle is different, which is why I think I made the comment that, if we’re targeting the bottom of the range, we’ve allowed for some future charge-offs should they occur, and right now we don’t see any, but if they occur, then we’ve allow some room for it and if all goes according to where we see the world right now, we should have an increased dividend by the end of the calendar year.

[Greg Mason:]

Alright and one last question, can you tell me the number of investments that were in categories three and four this quarter?

[Len Tannenbaum:]

Do we disclose that on a quarterly basis? I don’t know that I want to get into passing through the different categories, so that each one individual can be figured out.

[Greg Mason:]

You had provided it in the last quarter, so I was just looking forward to it again.

[Len Tannenbaum:]

I mean as we said, we have four assets that we’ve done on PIK non-accrual and two are non-performing. I will talk about two notable assets now that you brought the question. One of them is, you can notice CPAC was actually written up in the quarter and it is improving. In other words, that’s where you get write-ups from and as you know that’s a consumer focused issue for us and as the consumer seems to be recovering and we’ve seen more positive results, we’ve seen that valuation increase. So, I do want to point that out and that is a non-performing asset currently.

[Greg Mason:]

Then it looks like investment ratings three leverage ratios remained flat, ratings one and two, those leverage ratios improved. Is that from seeing better EBITDA or is that a function of your new investments that you’ve made?

[Len Tannenbaum:]

No, it’s a function of better EBITDA. I mean as I keep saying in each monthly newsletter, not only are we seeing EBITDA stabilization; aside from our very worst performing securities they’re improving in general and so we’re pretty encouraged and April showed a continuation of that improvement.

[Greg Mason:]

Then my last question, before I hop-off. It looks like, since the quarterly dividend was declared after the end of the quarter, is it correct to assume that there was a kind of $0.25 positive bump in the quarter, where you had no declared distributions?

[Len Tannenbaum:]

From an NAV standpoint.

[Greg Mason:]

From an NAV standpoint?

[Len Tannenbaum:]

Yes.

[Greg Mason:]

Okay, thank you.

[Operator:]

We’ll take our next question from Chris Harris with Wachovia.

[Chris Harris:]

Good morning. Thanks for taking my questions. The refinancing as you talked about in your prepared remarks, are those refinancing away from Fifth Street? In other words, are those two companies looking to refinance elsewhere, perhaps to one of your competitors?

[Len Tannenbaum:]

Yes, they’re looking to refinance elsewhere.

[Chris Harris:]

Okay, any particular reason why you wouldn’t look to refinances those investments yourself; are they kind of shopping a rate?

[Len Tannenbaum:]

Well, I mean the case of Elephant & Castle, we’ve heard a lot from Wall Street and our investors that; look we’re second lien in the restaurant. Every time we say that it’s doing well and all of them are making money, etc. nobody seems to believe us. The equity sponsor has been very supportive of the investment, it happens to be a good investment. The rate happens to be pretty good and because we’re no longer going to focus on second liens. It’s not, but we don’t like the sponsor, we do. We work really well with them, we have a great relationship, but now that we’re no longer focusing at second liens and this is viewed as a more risky security, which even though we don’t believe it is, we’ve agreed to a good financing solution with them. That’s not going to be refinanced with the competitor. In the other instance or instances, a number of companies are seeing more demand for private equity and there maybe a full sale of the company, maybe a partial sale of the company, it could be a refinancing. So don’t take the other second lien ones as a refinancing, these maybe just private equity firms exiting and been waiting for an exit opportunity and the window is starting to open again for next opportunities.

[Chris Harris:]

Okay, got it. I guess also looking at your press release, you’ve mentioned a little bit about the PIK interest have stopped accruing on four investments. Remind me, is that up from two last quarter?

[Len Tannenbaum:]

No, we had three un-PIK, non-accrual; two non-performing last quarter and now we have four un-PIK non-accrual, same two non-performing. So, we have two assets that aren’t paying.

[Chris Harris:]

Okay, great. Thanks.

[Operator:]

It appears we have no further questions at this time. I’d like turn the call back to our speakers for any additional or closing remarks.

[Len Tannenbaum:]

Thanks everyone for attending the call. Obviously, you’ve heard our level of optimism and excitement, which only continues into this quarter. We look forward to continuing to report improving and good results.

[Operator:]

Once again, that does conclude today’s call. We do appreciate your participation. You may disconnect at this time.