Portman Ridge Finance Corporation
Q3 2013 Earnings Call Transcript

Published: 8 Nov 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to the KCAP Financial, Inc. Third Quarter 2013 Earnings Conference Call. An earnings press release was distributed yesterday, November 7, 2013. If you did not receive a copy, the release is available on the company's website at www.kcapfinancial.com in the Investor Relations section. [Operator Instructions] As a reminder, this conference is being recorded today, Friday, November 8, 2013. This call is also being hosted on a live webcast, which can be accessed at our company's website, www.kcapfinancial.com, in the Investor Relations section under Events. In addition, if you would like to be added to the company's distribution list for news events, including earnings releases, please contact Denise Rodriguez at [phone]. Today's conference call includes forward-looking statements and projections, and we ask that you refer to KCAP Financial's most recent filings with the SEC for important factors that would cause actual results to differ materially from these projections. KCAP Financial does not undertake to update its forward-looking statements unless required by law. I would now like to introduce your host for today's conference, Mr. Dayl Pearson, President and Chief Executive Officer of KCAP Financial. Mr. Pearson, you may begin.

[Dayl W. Pearson:]

Thank you, and thank all of you for joining KCAP Financial for a review of the third quarter 2013. I will open the call, as always, with some broad commentary about important highlights and activities during the quarter, including the performance of our asset manager affiliates and our principal investment portfolio. I will then turn the call over to our Chief Financial Officer, Ted Gilpin, for him to provide a recap of our third quarter operating results and our financial condition at the end of the quarter. We will then open the line for your questions at the end of the call. First, let me provide a brief recap of some important highlights for the third quarter. In the third quarter of 2013, our net investment income, or NII, increased to $0.23, up from $0.20 from the second quarter. There are several reasons for this increase in NII. First, we successfully placed much of the excess cash during the course of the quarter and $54 million in new investments. Since the end of the third quarter, we've closed on another $12 million in new investments. Paydowns were minimal during the third quarter, although we did choose to exit one investment for less than $2 million. You will also remember that we closed at our equity investment in Catamaran 2013-1 on June 27, so we recognized almost no income on that investment in the second quarter but did have a full quarter of income in the third quarter. Our asset manager affiliates began warehousing for their next CLO fund in September. And as with previous warehouses, KCAP provided a $20 million loan to Trimaran to fund its investment in the warehouse. This is not included in the $54 million I've mentioned earlier. I will now review our portfolio of investments and our new origination activity. Deal flow in the middle-market lending business year-to-date has included reviewing 679 new deals. We have completed 46 new deals since the beginning of the year, many of which were middle-market, first-lien loans for our balance sheet securitization. We have committed to do additional deals totaling $8 million which will close in November. Of the $66 million in new investments made during the third quarter in October that I mentioned earlier, approximately $14 million were in so-called placeholder loans, $34 million in first-lien middle-market investments, $15 million in junior capital investments and $3 million in equity in a CLO managed by a third party. In October, we sold approximately $15 million in placeholder loans to fund new higher-yielding investments. Given the uncertain economic environment and volatile credit market, we continue to be cautious in terms of deploying the capital, and we continue to maintain adequate liquidity. The combined yield on our total asset portfolio was approximately 12% at September 30, 2013. As of September 30, our weighted average mark-to-market value on our -- to par at our debt securities portfolio was 95 compared to 89 for the second quarter. As far as CLO portfolio, our weighted average mark-to-market value to par was 68 as of September 30, a decrease from the weighted average mark-to-market to par of 71 for the second quarter. Our 100% ownership of our asset manager affiliates was valued at approximately $83 million based upon their assets under management and prospective cash flows. Our investment portfolio at the end of the third quarter totaled approximately $440 million. Looking at the composition of our investment portfolio, our portfolio quality continues to hold up well with no new assets and nonaccrual. At the end of the third quarter of 2013, our debt securities totaled approximately $257 million and represented about 58% of the investment portfolio. First-lien loans now represent 70% of debt securities and junior loans approximately 16%. Approximately 9% of our debt investments are fixed-rate investments, with a weighted average yield of approximately 12%. As of September 30, we had 4 issuers on nonaccrual status, representing less than 1% of total assets. All CLOs managed by KDA and Trimaran, our investment manager and affiliates, continue to be current on equity distributions and management fees. Four of the managed funds are now paying incentive fees to the asset manager affiliates. The stable income stream from our asset manager affiliates allows us to make periodic distributions to KCAP in the form of a dividend. In the third quarter, there was a distribution of $3.3 million compared to $3.3 million in the second quarter. Year-to-date, this has totaled $9.6 million. Additionally, as of September 30, our asset manager affiliates had approximately $3.4 billion of par value assets under management. As always, we continue to evaluate our equity and debt financing options, which will allow us to focus on continued balance sheet growth, increasing net investment income and dividend distributions. And now, I'll ask Ted Gilpin to walk you through the details of our financials.

[Edward U. Gilpin:]

Thank you, Dayl, and good morning, everyone. I'll now cover some of the financial metrics in the quarter. Net investment income was $0.23 per share for the third quarter of 2013, and as mentioned earlier, up 20% from the preceding quarter. Component parts that increased were as follows

[Operator:]

[Operator Instructions] And our first question comes from Troy Ward from KBW.

[Troy L. Ward:]

Can you speak, Dayl, about the originations in the quarter, kind of how we should view the timing of the originations and the yields that you saw? Obviously, you talked about placeholder investments that have subsequently been sold, just kind of walk us through the thought process. And what are the ultimate yields that you're getting in the portfolio today?

[Dayl W. Pearson:]

Yes, the placeholder investments, Troy, are generally yielding in somewhere between 4% and 5%. The middle-market first-lien loans generally are around 7% -- I'm sorry, around 6%, 6% to 7%, and the junior stuff is around 12%. So that's one way to look at it. And essentially, we didn't -- the stuff we bought earlier in the quarter was not the same stuff we necessarily sold in October. So we're going to see certain things go off and other stuff come on. But effectively, that's sort of the trajectory where we're headed. And in terms of timing, a lot of the stuff -- a big chunk closed in late July. Not much closed in August, as is normal. And then we had another bunch that closed in September. And as we mentioned, some things have closed in October.

[Troy L. Ward:]

As we think about kind of activity going into the end of this year and then for then -- let's just call it the first half of next year. What do you anticipate the mix of assets are between those first-lien and the junior and kind of what's the approximate yield that we should be thinking about for your new investments?

[Dayl W. Pearson:]

Well, I think, if I remember the numbers correctly, we have, sort in our securitization, about $35 million remaining of what we would call placeholder investments in that 4% to 5% range. And we would hope to move that into -- up by 200 basis points or so over the course of the rest of the fourth and the first quarter. We're not going to rush into things just to increase the yield, but we are seeing some steady activity. And we're working on a number of new middle-market first-lien loans now. So that's one thing. And then sort of outside the facility, most of what we're focusing on are sort of the higher-yielding junior things. As I said, we closed on a couple of things subsequent to the quarter, which fall into that category, and we're working on a couple of new originations there. So we'd like to move that sort of 12% overall yield up during the course of the fourth and first quarter. I think, as you mentioned, obviously, we didn't fully realize all the benefits in the quarter of the new investments we made. So some of that is just sort of -- you'll see some movement up because we'll have a full quarter of those investments in the fourth quarter.

[Troy L. Ward:]

Okay, great. That's good color. And then, you said you started warehousing the next CLO. Can you just speak to kind of the expected timing on that?

[Dayl W. Pearson:]

I think the expected timing is going to be based upon market conditions. We'd like to try to get something done by the end of the year. But to be honest with you, given where AAA pricing is now, we're not going to sacrifice returns and we're not going to rush to the market just to do something by year-end. So there's a chance that, that slips into the early part of the first quarter. But we plan -- I could do it this year. We're not going to do something that's not smart.

[Troy L. Ward:]

Okay. And then just one last one. I think you said the quarter-to-date originations already closed were $12 million. Can you speak to what the repayments have been in the portfolio?

[Dayl W. Pearson:]

In the quarter, so far, we had one broadly syndicated loan selloff for about $2 million, but that was a fairly low yielding investment. So -- and we had, as I said, in the quarter, we had one loan that we chose to exit because opportunistically, it was a loan that was on our soft watch list, and were able to sell it at a very attractive price, and so we just decided to exit it. But that's really it in terms of repayment activity.

[Operator:]

[Operator Instructions] And our next question comes from Mickey Schleien from Ladenburg.

[Mickey M. Schleien:]

Troy asked most of the questions that I was going to ask, but I do have a couple of others. First of all, with respect to restricted cash, you were carrying $6 million at the end of the third quarter. Is there some sort of working capital requirement that would limit your ability to use that cash, or can we see that go down further?

[Dayl W. Pearson:]

Yes, that sort of turns over. That's in the balance sheet securitization, so that's really sort of a timing of between investments not paying off and new investments being made. So that should go down, but it will go up and down during the quarter. But that's all something within the securitization.

[Edward U. Gilpin:]

Right. But that's not a requirement to keep it...

[Dayl W. Pearson:]

Yes, that is not. It's restricted just by the fact that it's there because loans have paid off and it's awaiting new investments. So we can use it. But we have to use it for investments within the facility.

[Mickey M. Schleien:]

With respect to the dividend from the affiliate asset manager, it looks like it stabilized at 3.3. Is there any scope for that to climb a little bit more as the newest CLO that they've created has seasoned? Or is this sort of a run rate that we can expect?

[Dayl W. Pearson:]

Well, I think if we close a new CLO, obviously, that will add fee income. But again, as older CLOs delever, the fee income from those will actually will go down. So you just have the sort of offsetting things until we sort of get past sort of the deleveraging period from some of the older CLOs. So hard to project whether it's going to grow or not during the course of the next couple of quarters unless we know.

[Edward U. Gilpin:]

Depends on the timing of new CLOs when they close.

[Dayl W. Pearson:]

Yes. And I guess I'll get to another point on that and that, obviously, we don't view our asset manager affiliates as purely CLO managers, and we are looking at other types of vehicles for them to invest in the loan and bond markets. So we're not just sitting here waiting for CLOs to get them.

[Mickey M. Schleien:]

Of course. My last question relates to the realized loss. I think that was due to eInstruction, is that correct?

[Dayl W. Pearson:]

That's correct.

[Edward U. Gilpin:]

That's correct.

[Mickey M. Schleien:]

So can you just walk us through the history of that investment and what occurred as they were acquired by -- what was it -- Turning Technology -- and what's the outlook for the equity that you still have there?

[Dayl W. Pearson:]

That was an investment that performed extremely well. It was an investment we made in 2007. We had both the first-lien and second-lien investment. The entire first-lien had been paid off. It was a company that provided products to school systems, which were related to tying in software to textbooks and lesson plans. And I think the company was doing extremely well and was poised to go public, and then the iPads sort of came and pretty much destroyed a big chunk of its business. And in terms of equity value, I think where we have a mark is what we expect.

[Mickey M. Schleien:]

And just to confirm then, did you reverse the unrealized depreciation that you had?

[Dayl W. Pearson:]

Correct, yes. Essentially, what happens is you -- that's why...

[Edward U. Gilpin:]

It moved from one bucket to the other.

[Dayl W. Pearson:]

It moved from one bucket to the other. It doesn't really impact net income or [indiscernible] at all.

[Mickey M. Schleien:]

Right, yes. Because CV [ph] they're about the same magnitude this quarter.

[Dayl W. Pearson:]

Yes.

[Edward U. Gilpin:]

Yes.

[Operator:]

And our your next question comes from J.T. Rogers from Janney Capital Markets.

[John T. G. Rogers:]

I guess, first off, just all else being equal on the syndicated loan market, where do you guys think AAA pricing needs to be for you guys to price in the fourth quarter? How much tightening would you be looking for?

[Dayl W. Pearson:]

That's -- there are so many different factors involved in raising new CLO. I think it's hard to put a stake in that number. Part of the problem is -- the headline number, as you may see in the rag [ph], so to speak, are not necessarily the actual numbers. Because those things get -- sometimes gets all of the big discounts, sometimes they don't. Now our last deal price sort of very attractively in June. The market is probably 200 basis points -- sorry, 20 basis points above that now. We clearly would like to see that come in, but it's a tough function of the portfolio, the leverage. And also, to be honest with you, the non-AAA portion of the capital structure continues to tighten quite a bit, and so there is some offsetting benefit there. So sort of a long-winded way of not answering your question because I'm not sure I have a perfect answer for your question.

[John T. G. Rogers:]

Okay. Looking at the manager, I think you said 4 CLOs were paying incentive fees. I'm wondering if you could put a number on those incentive fees? And then does that represent a full quarter run rate on incentive fees, or did you get half a quarter of incentive fee?

[Dayl W. Pearson:]

I would say, by and large, that's a pretty good run rate. I mean, one of them -- one of the ones that just turned on may have been a bit of a stub. But by and large, the run rate is the run rate.

[John T. G. Rogers:]

Did you have a number for that?

[Edward U. Gilpin:]

I think it's been -- I think we said before, it's about $1 million a quarter.

[Dayl W. Pearson:]

Give or take.

[Edward U. Gilpin:]

Give or take.

[John T. G. Rogers:]

Okay. And then on management fees, you said that the full quarter benefited of Catamaran on the senior fees. What I wonder if are there other fees that may ramp up for Catamaran 2013 as that becomes fully invested?

[Edward U. Gilpin:]

No, you pretty much have a full quarter of management fees.

[John T. G. Rogers:]

Okay. And then I just...

[Dayl W. Pearson:]

Obviously, one thing they do benefit from is the net spread on the warehouse. The manager gets that which, obviously, covers the interest on our loan that we make to the manager.

[John T. G. Rogers:]

All right. And then, just sort of finally, what other vehicles are you looking at? I don't know if it's too early to talk about that, but what else could you see Katonah managing?

[Dayl W. Pearson:]

Well, I think there are a lot of different vehicles out there with that, and we're looking at any and all. I mean, there are different types of managed accounts, there are different types of closed-end funds. There are different types of other vehicles, either public or private, that we're looking at. So we're looking, as we always do, at any and all potential ways to continue to grow our asset management business.

[Operator:]

And we do have a follow-up from Troy Ward from KBW.

[Troy L. Ward:]

Dayl, just following up on J.T.'s questioning there. Can you speak to what the dividend stream was from Catamaran '13? Have you started to receive any of that? And if not, when will that kick in, the equity?

[Dayl W. Pearson:]

You mean the equity returns?

[Troy L. Ward:]

Yes.

[Dayl W. Pearson:]

We're targeting at 15% IRR. So I think...

[Edward U. Gilpin:]

And it is -- we do -- it is in the financials because we accrued for it.

[Troy L. Ward:]

Okay. And then, if you look at the income statement on the CLO, the unrealized depreciation we've seen in the CLOs managed by affiliates. Can you just give us some color on, I guess, what that is? There's $2.5 million this quarter and $10.8 million year-to-date.

[Edward U. Gilpin:]

Yes. I mean, again, as the -- you're talking about on the equity -- the sales of the asset manager, sorry, I missed it.

[Troy L. Ward:]

The equity, the CLO fund.

[Edward U. Gilpin:]

Yes. So in other words, as they delever, there's decreased cash flow to the company. So when we're not adding a new CLO, you'll see the runoff will be -- affect the value of our CLOs and our asset manager affiliates.

[Dayl W. Pearson:]

The other point to make is, as incentive fees are earned, obviously, that reduces distribution, which reduces values. But on the other hand, we're getting 100% of the incentive fee of the asset managers. So those tend to offset each other.

[Troy L. Ward:]

But when you -- as you're writing down the fair value -- so if we have -- for instance this quarter, it's a negative 2.5. Does that mean that the cash -- the assets are going down faster than you're modeling in the fair value assumptions?

[Edward U. Gilpin:]

No. I mean, maybe a little bit faster, yes, but I mean I think it's mostly that as you lop off cash flows, the remaining value is discounted back and it's just lower. As you recall, we received -- the way we do the financials, it's a residual value piece. We receive excess cash flows. We book it all as income -- when it comes. Some of that is -- sometimes you get paid more upfront and less in the back and it's just -- we just value the cash flow. So you're getting back some of your principal when you get paid -- as it pays down and then when you -- obviously, what's left on there is what you expect to get if it's called or if you sold it. So it will tend to stabilize at where it's going to -- where its value will be on its call date.

[Operator:]

And I'm not showing any further questions at this time. I would now like to turn the call back to Dayl Pearson for any further remarks.

[Dayl W. Pearson:]

Thank you very much, and thank you, all, for participating, and thank you for your questions. And we'll speak to you again soon. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.