Oxford Square Capital Corp.
Q3 2013 Earnings Call Transcript

Published: 7 Nov 2013

[Operator:]

Good morning, and welcome to the TICC Capital Corp. conference call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jonathan Cohen. Please go ahead.

[Jonathan H. Cohen:]

Thank you. Good morning. Welcome, everyone, to the TICC Capital Corp. third quarter 2013 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 the 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 a 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 could cause actual results to differ materially from those 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, www.ticc.com. With that, I'll turn the presentation back over to Jonathan.

[Jonathan H. Cohen:]

Thanks, Bruce. As we noted in our press release this morning, TICC reported core net investment income of approximately $0.28 per share to the third quarter of 2013. We reported total investment income of approximately $27.4 million record for the quarter, representing an increase of approximately $2.0 million over the second quarter. That increase was largely due to greater interest income and distributions from our CLO equity investments during the third quarter. Our third quarter net investment income was approximately $12.2 million or $0.23 per share, which includes the impact of a capital gains incentive fee accrual of approximately $2.3 million. Excluding the impact of that fee accrual, our core net investment income was approximately $14.5 million or $0.28 per share. We also reported net unrealized appreciation of approximately $12.7 million and net realized capital losses of approximately $1.3 million for the quarter. As a result of those unrealized and realized gains and losses, we had a net increase in net assets resulting from operation of approximately $23.6 million for the quarter. At the same time, we believe that the credit quality of our portfolio remains stable. Our weighted average credit rating on a fair value basis stood at 2.1 at the end of the third quarter of 2013, compared to 2.2 at the end of the second quarter of 2013. By way of reminder, the lower the number, the higher the credit quality. At September 30, 2013, net asset value per share stood at $9.90, compared with the net asset value at the end of the second quarter of $9.75. During the third quarter of 2013, we made additional investments of approximately $85 million. Those additional investments consisted of approximately $62.1 million in corporate securities, $17.2 million in CLO equity, and $5.7 million in CLO debt. It is worth noting that for the 9 months ended September 30, 2013, we invested approximately $492.3 million, consisting of $351.1 million in corporate securities, $124.1 million in CLO equity and $17.1 million in CLO debt. Through the third quarter, we received proceeds of approximately $61.9 million from repayments, sales and amortization payments on our debt securities. For the quarter ending September 30, 2013, TICC recorded earned income from our investment portfolio as follows

[Operator:]

[Operator Instructions] Our first question comes from Kyle Joseph of Stephens.

[Kyle M. Joseph:]

Jonathan, would you say that the third quarter -- we've talked in the past about the contribution of CLO equities to earnings and how there's a little bit of a delay from investment to earnings there. Would you say that the third quarter is reflective of a bit of a run rate now given how much you've deployed into that asset class?

[Jonathan H. Cohen:]

I think we've seen an improvement third quarter over second quarter in terms of the CLO equity positions that we hold generating income for us. I don't think that we've seen the full magnitude of that manifest itself yet in our financial performance.

[Kyle M. Joseph:]

Great. And then so you had no investments on nonaccrual. I remember a few quarters ago, you actually purchased an investment that was on nonaccrual. Can you explain -- did you sell that or did you restructure it? Can you explain what happened there?

[Jonathan H. Cohen:]

We didn't sell it. We didn't restructure it. The company has performed better, and as a result, it came off nonaccrual status. It's now on accrual.

[Kyle M. Joseph:]

Okay, even better. And then can you talk a little bit about deal flow trends throughout the quarter? Was it mostly investment activity towards the end? And was deal flow accelerating into the fourth quarter? And what are your outlooks for deal flow on the fourth quarter?

[Patrick Francis Conroy:]

I think our outlook for deal flow into the fourth quarter and into 2014 is strong. We were capital-constrained in the third quarter in terms of available capital to deploy, I think to a much greater extent than we were opportunity-limited. So the pace of activity in the third quarter, I think, was dictated by available capital as opposed to those opportunities that were available to us.

[Kyle M. Joseph:]

Okay. And then just a nitty question here. But on your repayments, were those just on -- that you disclosed in the press release, were those just debt investments? Or did that include any CLO investments as well?

[Jonathan H. Cohen:]

It included both things.

[Kyle M. Joseph:]

Okay. And then so it looked like the yield on the portfolio on the debt investments expanded a bit in the quarter. Can you give us some color on that? Was that a result of the -- a little interest rate spike in the second quarter moving into the third quarter? Or are you looking -- targeting a different asset class? What's going on there?

[Jonathan H. Cohen:]

I don't think, Kyle, it's related to anything systemic in the portfolio. It was really just a function of the normal ebbs and flows of our investment activity.

[Operator:]

The next question comes from Greg Mason from KBW.

[Greg M. Mason:]

Great. Could you talk a little bit about new CLO equities and what types of yield you're seeing on those investment opportunities today versus 6, 9, 12 months ago?

[Patrick Francis Conroy:]

Greg, the CLO activity that we've engaged in tends to fall across a fairly wide spectrum. So I wouldn't say that the deal flow that we've seen either in the secondary market or in the primary market for CLO transactions are coalescing tightly around a particular data point. We're generally targeting returns in the low teens, low teens to midteens. But those returns are highly assumption-driven, and they're also highly variable transaction to transaction.

[Greg M. Mason:]

Would you say that in general, the equity returns have been coming down meaningfully over the last 12 months? Or has it been relatively stable for CLO equity?

[Jonathan H. Cohen:]

I would say they've been trending down, but I wouldn't say they've gapped down in a meaningful way. And again, I'd caveat that statement by reiterating what I've said a moment ago, which is that there is a fairly wide dispersion pattern for these transactions.

[Greg M. Mason:]

Okay, great. And then could you give us any additional color on the significant appreciation in investments this quarter? Was that coming from the CLO book, particular debt investments? Any color there?

[Jonathan H. Cohen:]

Sure. We had some markups in the CLO portfolio certainly. And the significant distressed asset or asset that we held on nonaccrual status, which has seen improved financial performance and, as a result, is now on accrual status, was marked up as well in addition to the normal markups and markdowns that attend any particular quarter.

[Greg M. Mason:]

Could you give us a magnitude of that one investment, where that went to on a fair value basis this quarter?

[Jonathan H. Cohen:]

I think it was marked last quarter, Patrick, at -- in the 35% range...

[Patrick Francis Conroy:]

In the 70% range now. But 35%, probably 35% to 72% for that one position.

[Operator:]

And the next question comes from Mickey Schleien of Ladenburg.

[Mickey M. Schleien:]

Wanted to follow up on the question, I mean, we're all sort of keyed in on the CLO market here. But my question is the following. We know we've seen at the more liquid end of the middle market, terms have changed substantially, more leverage in the deals. Spreads have compressed. It's generally not -- it's favorable to issuers, not so favorable to investors. So how is that affecting your appetite in the primary market for CLOs on a go-forward basis?

[Jonathan H. Cohen:]

It's diminishing it.

[Mickey M. Schleien:]

So are you -- looking at this -- the current quarter, are you going to take advantage and maybe realize some gains in this kind of a market in the CLO?

[Jonathan H. Cohen:]

Well, I think there are 2 offsets to the dynamic you've just described, Mickey. The first is the cost of capital on the liability side of our balance sheet, and the second is the corporate credit market environment broadly, including corporate default rates, which are very low at present and are a natural offset to the lower corporate spreads that we're seeing in the market. On any given day, we're looking to sell positions if that's desirable for us. We're looking to buy positions if that's desirable for us. I don't think we're viewing the syndicated corporate loan market broadly or the middle market portion of the syndicated loan market as being generally overpriced right now, although pricing has certainly increased, and corporate spreads have diminished, just as you say.

[Operator:]

The next question comes from Jon Bock with Wells Fargo.

[Jonathan Bock:]

Just as it gets to the CLO investment portion -- and it was great to have Kyle, Greg, Mickey, everybody kind of dialing in on this, where have asset spreads gone in your CLO collateral, L plus what over the past, let's say, 12 months?

[Jonathan H. Cohen:]

I don't think we've disclosed asset spreads within the various CLO portfolios, either on an individual basis, Jon, or on a combined basis. Spreads have trended down certainly over the course of the last year. That said, again, the cost of capital for new CLO vehicles has been trending down over a long period of time now...

[Jonathan Bock:]

Right. And how many of...

[Jonathan H. Cohen:]

Offset.

[Jonathan Bock:]

Understood. So for new deals, that makes sense. But for existing deals currently on balance sheet, that not necessarily so. Question would be, where are you as it relates to the call period for the CLO equity that you do have? And what type of ability do you have to affect a call outcome?

[Jonathan H. Cohen:]

Well, it depends on the individual deal, it depends on the provisions of the deal, and it depends on our position in the equity where -- whether our equity position represents a majority stake or not. Those -- that's different really deal to deal. But your larger point, I think, is a completely valid one, which is that as corporate spreads diminish and have diminished, all things held equal, an existing CLO vehicle will become less profitable for the equity. That is certainly a true statement.

[Jonathan Bock:]

And I guess just kind of maybe getting back, where would you generalize call protection, until what year in the CLO portfolio today? Are they out of call? Could they be called today? Or do you have an additional view?

[Jonathan H. Cohen:]

On a weighted average basis, I'd say we're a few years, 2-plus or minus years away from the end of their respective reinvestment periods. But again, we have deals that are out of reinvestment. We have deals that are brand-new, that have many years of reinvestment in front of them. We have actively traded this portfolio on occasion, so we've traded out of deals, in many cases, 1.0 transactions that are out of reinvestments or going to soon be out of reinvestment into deals with longer maturities. So again, it's hard to generalize and say that we are a specific number of days or years away from being outside of reinvestment, a, because of just the disparity of the vintages of our portfolio; and b, because we do trade the portfolio.

[Jonathan Bock:]

Sure. And then the amount of subordinate notes that you own, let's say, ahead of specific equities, do you own subordinate notes ahead of potential equity that has or will be coming off of call protection in the next 12 months?

[Patrick Francis Conroy:]

Jon, when you say subordinated notes, you mean -- are you talking about what we classify in the schedule investments as sub-notes with respect to the equity positions?

[Jonathan Bock:]

Actually, yes, that's a good clarification. This would be a security. Let's just call it a B note that would be ahead of the CLO equity or subordinate certificate. So let's just call it ahead of the bottom floor of the CLO structure. A bit curious as to your exposure in those loans that sit above the equity and do have the potential to generate meaningful gains in the event that the loan the CLO is called.

[Patrick Francis Conroy:]

Oh, sure. Oh, yes.

[Jonathan H. Cohen:]

Oh, absolutely. I mean, yes. The answer to your question is yes. We hold positions in B notes and BB notes that are senior to equity tranches within various CLO vehicles that are -- that have the potential to economically benefit in the event of an early call. No question about that.

[Patrick Francis Conroy:]

Jon, just so you know, just for the nomenclature, the area, often you'll see, what we loosely refer to as the equity or actually technically, the entitled subordinated notes, sometimes they're called -- sometimes it's called preferred stock, but sometimes it's called subordinated notes. So just so you understand the terminology.

[Jonathan Bock:]

Appreciate that. Then I guess the only other question I have is, how would you characterize the second-lien buckets broadly in the CLOs that you hold?

[Jonathan H. Cohen:]

They have shrunk as we've transitioned from 1.0 CLO transactions into 2.0. I don't think we're seeing a sea change recently in terms of either the requirements for OC tests or WARF scores or second-lien baskets or CCC baskets. We're in a reasonably stable market environment, I think, with respect to those various elements.

[Jonathan Bock:]

Okay. So some would argue that the second-lien basket is in excess of 50% or maybe around there. Is that number too high or too low?

[Patrick Francis Conroy:]

That's way too high.

[Jonathan Bock:]

So 30%?

[Patrick Francis Conroy:]

Well, again, it depends on which one you're talking about. Does it....

[Jonathan Bock:]

Yes, let's -- we will go current lien. When a lot of the deals were actually transacted post-credit crisis, so we'll do CLO 2.0. Where do see the second-lien baskets today?

[Jonathan H. Cohen:]

A representative figure might be around 10%, again, with variability around that figure.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Jonathan Cohen for any closing remarks.

[Jonathan H. Cohen:]

We'd like to thank everyone for their interest and their participation in this call. We look forward to talking to you intra-quarter and at the end of the fourth calendar quarter. Thanks very much, everyone.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.