Oxford Square Capital Corp.
Q4 2012 Earnings Call Transcript

Published: 12 Mar 2013

[Operator:]

Good morning, and welcome to the TICC Capital Corp. Year End 2012 Earnings Release and Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Jonathan Cohen, CEO. Please go ahead.

[Jonathan H. Cohen:]

Thanks very much. Good morning. Welcome, everyone, to the TICC Capital Corp. Fourth Quarter 2012 Earnings Conference Call. I'm joined today by Saul Rosenthal, our President and Chief Operating Officer; Patrick Conroy, our Chief Financial Officer; and Bruce Rubin, our Controller and Treasurer. Bruce, could you open the call today with a discussion regarding forward-looking statements?

[Bruce L. Rubin:]

Sure, Jonathan. Today’s call is being recorded. An audio replay of the conference call will be available for 30 days. Replay information is included in our press release that was released earlier this morning. Please note that this call is the property of TICC Capital Corp. Any unauthorized rebroadcast of this call, in any form, is strictly prohibited. I’d also like to call your attention to the customary disclosure in our press release this morning 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 at the SEC for important factors that can cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required to do so by law. To obtain copies of our latest SEC filings, please visit our website at www.ticc.com. With that, I'll turn the presentation back to Jonathan.

[Jonathan H. Cohen:]

Thanks, Bruce. For the fourth quarter, TICC reported core net investment income of approximately $0.25 per share and a core net increase in net assets resulting from operations of $0.36 per share. For the year ended December 31, 2012, we reported core net investment income of approximately $1.12 per share and a core net increase in net assets resulting from operations of approximately $1.94 per share. We currently anticipate that our 2012 dividend distributions will have been fully covered by our earnings, and therefore, represent no return of capital on a taxable basis. At December 31, 2012, our net asset value per share stood at $9.90 compared with a net asset value at the end of the third quarter of $9.85. We reported total investment income of approximately $20.4 million for the fourth quarter of 2012, representing an increase of approximately $4.8 million from the third quarter. That increase was largely due to greater interest income and distributions from our CLO equity investments during the fourth quarter. We also recorded net realized capital gains of approximately $13.3 million and net unrealized depreciation of $8.6 million for the quarter, including the corresponding reversal of net unrealized depreciation associated with fourth quarter realization events. Our fourth quarter GAAP net investment income was approximately $9.4 million or $0.23 per share, which includes the impact of a capital gains incentive fee accrual of approximately $949,000. Excluding the impact of that accrual, our core net investment income was approximately $10.3 million or $0.25 per share. On a GAAP basis, again, our net increase in net assets resulting from operations was $0.34 per share. Our weighted average credit rating on a fair value basis was 2.1 at the end of the fourth quarter of 2012, representing improvement, compared with our credit rating of 2.2 at the end of the third quarter of 2012. During the fourth quarter, we invested approximately $247 million of additional capital. In addition to the prior 3 quarters gross investment of approximately $248 million, we had a total deployment of approximately $495 million for 2012. Looking back at the full year ended December 31, 2012, we raised gross proceeds of approximately $317 million associated with 2 equity capital raises, our CLO 2012-1 and our 2007 -- '17 convertible note offering. For the quarter ended December 31, 2012, TICC recorded earned income from our investment portfolio as follows

[Operator:]

[Operator Instructions] Our first question will come from John Hecht of Stephens.

[John Hecht:]

First of all, I wonder if you can characterize the timing of the investments during the quarter? Were these back-end weighted or was it fairly balanced throughout the quarter?

[Jonathan H. Cohen:]

It leaned a little bit, John, more towards the back end of the quarter.

[John Hecht:]

And what's the -- I mean, can you characterize some of the investments? What was the average loan size, your kind of mix of senior versus second lien and so forth?

[Jonathan H. Cohen:]

Sure. I mean it was a fairly diverse mix, John, during the quarter. We did buy some second lien, not a great deal. Most of the positions that we took during the quarter were first lien positions as we looked to put the capital that we raised within the CLO structure, the 2012 CLO structure, to work. So that was an ongoing project towards the latter part of last year. We took...

[Saul Barak Rosenthal:]

Also the convertible notes that we had.

[Jonathan H. Cohen:]

Also the convertible note issuance, we put that money to work as well. We bought positions in the primary market. We bought a fair number of positions as well, though, in the secondary market. The mix was more primary than secondary during the fourth quarter. We also took some new positions in CLO equity. I don't believe we bought any new BB positions during the fourth quarter. We bought, I think, 1 single B position, so there's a single B tranche that we've been looking at in a couple of deals. And we did buy some new CLO equity positions selectively during the quarter.

[John Hecht:]

Okay. And where did the realized gains come from?

[Jonathan H. Cohen:]

The realized gains, John, came primarily from the sale of some of our legacy BB positions, primarily in the fourth quarter. So as you know, the CLO market has been particularly active recently, which is to say over the course of the last 6 months to 1 year, there've been a great number of new primary issuances. And at the same time, prices have been rising generally for both CLO equity positions and CLO BB tranches. We took advantage of some of that strength in the market to realize some capital gains on our BB positions. I think those were all 1.0 vintage, meaning that they were all vintage 2005, '06, '07 BB positions for us.

[John Hecht:]

Okay. And given the gain there and it sounds like the redeployment into some other CLO investments, what should we expect for effective yields in that portfolio in the coming quarters?

[Jonathan H. Cohen:]

Well, we don't have a specific point estimate that we've gone out with in terms of the numbers, John. I mean, as you've seen, as we've talked about and I think as was in the press release this morning, there was a diminishment in our weighted average yield at the end of the fourth quarter compared to the prior quarter. That was largely, by design, as a result of having raised low-cost financing. So we have the ability within our 2 CLO structures, our 2011 vehicle and our 2012 vehicle, to deploy capital in higher quality collateral, in higher rated corporate loans, and still generate positive spread income as a result of the low cost of capital within those 2 structures.

[John Hecht:]

Okay. And then last question, is it -- the nonaccrual, is that the same nonaccrual as last quarter, just out of curiosity?

[Jonathan H. Cohen:]

It is, John. Yes. There's been no change.

[Operator:]

Our next question is from Boris Pialloux of National Securities.

[Boris E. Pialloux:]

Just to -- I want to touch base with the equity CLO, do you have any indication about the cash yield on these investments?

[Jonathan H. Cohen:]

We haven't made, again, Boris, specific projections with respect to cash yields on CLO investments, CLO equity investments. We are seeing a range of opportunities right now. So we've seen, post reinvestment, vintage paper, 1.0 paper, that may have a higher current yield at the expense of a lower capital recovery. We've seen 2.0 paper, recent paper, both in the secondary and in primary market where there's a different set of trade-offs in terms of the current yield, the ultimate return of principle or the potential for a capital gain over the life of the vehicle. So there's no sort of one single number that we're comfortable broadcasting. The other element, of course, is the risk profile of these various vehicles. Certain CLO structures are more or less highly levered. They have different collateral compositions. They have different assets inside of them. They have different indenture tests. So all of these things weigh heavily on our decision-making process and thoughts as we architect the portfolio.

[Boris E. Pialloux:]

And second thing, you mentioned that you were actually buying, am I correct, like investment grade CLO debt tranches? Like you were buying both BB with your new CLO proceeds? Am I correct or...

[Jonathan H. Cohen:]

No, Boris. I mentioned that we bought a single B tranche. The single B, obviously, is below the BB in terms of the rating and the waterfall construct. We really don't have the focus or probably the ability to buy a CLO paper very much senior to the BB tranche because in order to generate appropriate returns, we'd have to leverage those investments at a rate that would be difficult for us. So we continue within TICC to be focused on BB and equity tranches within the various CLO structures that we look at. One interesting question that you sort of have suggested, Boris, but didn't ask directly, revolves around the ratio of our vintage paper to the more recent CLO tranches that we hold. And that's something that's worth a mention. At December 31, approximately 61% of the portfolio, of the equity portion of the CLO portfolio, was invented -- was invested in 1.0 vintage paper, meaning CLO vehicles that were originated in 2005, '06, '07 or '08. And about 39% were invested in what are called 2.0 CLO positions, meaning originated in 2010, '11, '12 and '13. So that's an interesting statistic. Over time, that number will begin to favor the 2.0 vintage paper, which has some different characteristics to it.

[Operator:]

Our next question comes from Mickey Schleien of Ladenburg Thalmann.

[Mickey M. Schleien:]

I wanted just to get a sense, if you could quantify for -- you've been very active in raising capital over the last few quarters. I wanted to know if you could quantify, or to what extent you could quantify, the drag on NOI per share as it's -- taking into account the lag in investing that capital?

[Jonathan H. Cohen:]

Well, there has been a drag. There always is to some greater or lesser extent. I think we've done a generally good job of minimizing that lag by raising discrete amounts of capital that have been generally earmarked for specific investment strategies or even for specific investment opportunities as a goal. So I can't quantify for you in terms of an earnings per share or an NII diminishment for a particular quarter. But certainly, there has been some drag. Again, our expectation, now that we have deployed essentially all or the bulk of that capital, is to enjoy the benefit of that money producing a return.

[Mickey M. Schleien:]

Well, that's a good way -- segue into my next question. So you have restricted cash of $21 million as of December 31. I imagine, at that point, it was in the second CLO, is that correct?

[Jonathan H. Cohen:]

Correct, Mickey. Yes.

[Mickey M. Schleien:]

Okay. And then you had $51 million of unrestricted cash. And then you raised $60 million of incremental funds from the second CLO in February. So that's, what, $130 million, $135 million? Did you say that all of that has been invested at this point in time?

[Jonathan H. Cohen:]

We are substantially fully invested or largely fully invested at the moment, yes. I mean given that we deployed just under $250 million of capital in the fourth quarter, we have been running at a run rate where those amounts have not presented a significant challenge for us to deploy.

[Mickey M. Schleien:]

All right. So just on a go-forward basis, as we think of the first quarter, looks like roughly $80 million will be going into syndicated leverage loans. The other $50 million -- $51 million, the unrestricted cash, I haven't done the math yet, I don't know where you are in terms of the 30% limit on your nonqualified assets. Could you -- can you give us a sense of where you're looking to deploy the other $51 million?

[Jonathan H. Cohen:]

Sure. I mean, this -- the investment strategy remains just the same. So we continue to look at first and second lien, primarily U.S. corporate loans, both broadly syndicated corporate loans and middle market loans, at the same time. The middle market loans will tend to get done on balance sheet. The more broadly syndicated loans will tend to get purchased within the CLO vehicles where we can more efficiently finance them and arbitrage that interest rate spread. We continue to look at CLO opportunities, both BB. But I'd say, in the 2.0 world, we've had a heavier emphasis more recently on equity tranches. And the bilateral loan market continues to be of interest to us, although we haven't done very much there recently. So the strategy remains unchanged, and at the same time, remains opportunistic. We will deploy capital where we see the best and highest risk-adjusted return.

[Mickey M. Schleien:]

Fair enough. And just one -- or one last question, if I may. Can you tell us what your taxable income per share was in the fourth quarter?

[Jonathan H. Cohen:]

Patrick?

[Patrick Francis Conroy:]

Well, Mickey, taxable income isn't determined on a quarterly basis or under any set of circumstances. All I would say is that we -- it's on our dividend policy to be consistent with our anticipated taxable distributable income. So again, it's not targeted on a quarterly basis. We -- Jonathan did indicate that in 2012, it will not be return to capital.

[Mickey M. Schleien:]

Right, you covered the dividend from taxable income. Will there be significant spillover taxable income, Patrick?

[Patrick Francis Conroy:]

Again, I need you -- let me just say this. You don't know that until you file your tax return. Not to be coy about this, but we have a number of CLO equity positions which report rather late in the year and we have to wait for those reports to come in, and there does exist a potential that they could have something we didn't anticipate, but by and large, we won't know that until we file a tax return. But right now, I have no concern about tax return to capital. We have do have a cushion built into it, but I can't really describe that. But suffice it to say that we'd -- I would not anticipate a tax return to capital when we file the tax return.

[Operator:]

Our next question is from Jonathan Bock of Wells Fargo Securities.

[Jonathan Bock:]

Jonathan, maybe talking about -- a bit about the current deployment environment in a little bit more detail. I know that you've -- you're looking at a lot of differing investment opportunities to date and you remain opportunistic. Perhaps maybe, quality rank, what you would see in the current origination quarter between CLO equity first and second lien loans as well as the bilateral loans? So maybe just give us a sense of proportion and how that ties to the relative attractiveness to date.

[Jonathan H. Cohen:]

Sure, Jon. I can't really provide you with percentages or even a relative ranking because we really do tend to look at every transaction on a discrete basis. If we see a new CLO primary where we have the ability to take an anchor equity position on economic terms that we think are particularly compelling, the deal is sufficiently ramped, we're comfortable with the collateral base and the AAAs have locked in at a compellingly tight spread, that carries a certain level of attractiveness for us. That's a completely different investment opportunity and to some extent an uncorrelated or non-correlated investment opportunity from a second lien, secondary position in a U.S. -- from a U.S. corporate issuer where we like the business. I think we understand the market dynamics, I think they have a strong competitive position, a good product set and we like management. So those 2 things are truly different in kind. And it's difficult to rank the kinds of opportunities that we're seeing according to type by virtue of the fact -- again, that we really do tend to look at all these things differently. We're seeing some corporate loans that we like. We're seeing some CLO positions that we like, both in the primary and the secondary market. We think the middle market continues to look relatively attractive from a corporate issuance perspective. But all these things get done more or less in real time. We don't kind of go into the quarter saying we want to deploy x percentage in this strategy or y percentage in that. It really is where we're seeing the best risk-adjusted opportunities.

[Jonathan Bock:]

Sure, and I appreciate the color. Really, the genesis of the question kind of gets down to the point that really today, in light of refinancing activity and substantial CLO activity in both the middle market -- excuse me, in the broadly syndicated market, it's a pretty difficult time to be originating assets at attractive risk-adjusted returns in certain categories, and to the extent that there's additional color there, I know investors appreciate it. But -- so maybe moving on, one question as it relates to CLOs, can you walk us through the risk, not as the result of increased defaults because in this environment, it's relatively benign, but what happens to CLO equity returns in the event that asset spreads compress as they have done over the past 3 months?

[Jonathan H. Cohen:]

Sure. I mean, ceteris paribus, returns go down.

[Jonathan Bock:]

Okay. So maybe walk us through how you try to mitigate that potential risk, in light of the fact that you're buying CLO pri -- you see some opportunities in primary equity at this point in the quarter.

[Jonathan H. Cohen:]

Sure. I mean, the best possible method for trying to maximize the return and at the same time minimize the risk of any particular CLO equity trade is to buy the paper as advantageously as possible relative to the underlying NAV. So that's something that we spend a lot of time thinking about and we model and we look at the underlying collateral. And at the end of the day, we're running our models and we're looking at the future cash flows and we're looking at the return of capital, the return of par or NAV at the end of the life of the vehicle. And there are a variety of strategies that we can and have employed. But you're right. I mean, in a declining spread environment, any instrument with a fixed cost of capital on a spread over LIBOR basis will be disadvantaged. There's no question about that. Now I suppose the corollary is that in a declining spread environment, there is a -- the likelihood or the possibility, in any case, of a concurrent diminishment or the persistence of a low default rate because it would be difficult to maintain low spreads in a high default rate environment. So those 2, I suppose, are correlated.

[Jonathan Bock:]

I appreciate it. And Jonathan, of the CLO primary equity that you buy, what percentage of the underlying securitization, the collateral, is actually invested versus to -- on a -- versus to be invested? Or are majority of the CLOs that you're buying fully invested in the underlying collateral at a point when -- which you buy the equity?

[Jonathan H. Cohen:]

Sure, Jon. That's a great question. I mean we're targeting or we're trying to target 60% or greater as a benchmark.

[Saul Barak Rosenthal:]

For primary.

[Jonathan H. Cohen:]

For primaries, of course. In secondaries, the numbers going to be very much substantially higher. But there are other factors that we have to consider as well, most relevantly indenture structure, the nature of the underlying collateral that's populating the investment portfolio, and price, of course. So those are all important factors, but the percentage of deployed capital is critical as you say.

[Jonathan Bock:]

Okay. And then maybe just a question in terms of how the CLO income flows into the income statement, kind of a GAAP versus cash. Are -- is the income that you're receiving in terms of distributions off the equity, is that modeled income that flows into the income statement or is that purely cash?

[Patrick Francis Conroy:]

Basically, that's the cash number, Jon. It's considered a -- it's a dividend on what is effectively an equity tranche.

[Jonathan Bock:]

Okay, great. Okay. And so then the -- just moving on, I know -- I believe Mickey hit on this point earlier, would you be able to tell us to date where you are at with the current nonqualified asset bucket, just on a percentage basis?

[Jonathan H. Cohen:]

I mean we're fairly close to the statutory 30% figure. I mean, at any given moment we're going to be reasonably close to that number. We have, obviously, our CLO portfolio. There may, at any given moment, be a much smaller percentage of non-U.S. issuers or U.S. public companies with market capitalizations that exceed the statutory threshold. But we're -- we are and plan to remain reasonably close to the 30% figure.

[Jonathan Bock:]

It's great. And then maybe in terms of the forward opportunity, obviously, the CLO trade -- the CLO investment rather has been a very successful investment for you guys, particularly with the gains that you've realized and then also with the -- and at the returns that you're collecting off the book today. However, now that you're close to that reasonable cap, can you maybe outline what you would believe to be the forward opportunity set, in light of the fact that one of the more attractive return vehicles is now likely going to be limited to a percentage of your portfolio?

[Jonathan H. Cohen:]

Well, we've been limited by that figure, Jon, for a long time. So I mean, we've been operating under the 30% nonqualified asset test basket limitation for the better part of a couple of years. And it's something that we take into account as we're building the portfolio, as we're modeling out our returns and as we're making our investments. At the end of the day, we really view ourselves as corporate debt investors. And the mechanisms by which we approach that very large and diverse market are varied. But at the end, everything foots back to that discipline.

[Saul Barak Rosenthal:]

And Jon, don't forget that we've got our very low cost long-term CLO financing in place. And so in terms of investment opportunity set, we're investing in market that is comfortably supported by that debt.

[Jonathan H. Cohen:]

Right, right. So to Saul's point, Jon, I mean as -- should spreads rise, obviously, we'll see the benefit of that or we should see the benefit of that within our existing 2 CLO structures.

[Jonathan Bock:]

I couldn't agree more about securitization financing as an attractive way to finance the balance sheet.

[Jonathan H. Cohen:]

Jon, thank you, thanks very much. Operator, are there any additional questions?

[Operator:]

None. This will conclude our question-and-answer session. I'd like to turn it back over to you, Mr. Cohen, for any closing remarks.

[Jonathan H. Cohen:]

Great. All right. Well, thanks very much, everybody, for your interest and your participation in this call. We look forward to speaking to you during the quarter or at the next conference call. Thanks again.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation, you may now disconnect.