Saratoga Investment Corp.
Q2 2010 Earnings Call Transcript

Published: 16 Oct 2009

[Operator:]

Good day everyone and welcome to the GSC Investment Corp’s second quarter fiscal 2010 results conference call. At this time, I would like to turn the call over to the company’s Chief Financial Officer, Mr. Rich Allorto. Mr. Allorto, please go ahead.

[Richard Allorto Jr.:]

Thank you. I would like to welcome everyone to GSC Investment Corp’s, second quarter fiscal 2010 earnings conference call. Before we begin, I need to remind everyone that this conference call contains statements that, to the extent they are not resuscitations of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual outcomes and results could differ materially from those forecast due to the impact of many factors. We do not undertake to update our forward-looking statements unless required by law. A replay of this conference call will be available from 01

[Seth Katzenstein:]

Thank you Rick, and welcome to all of our shareholders. During the quarter ended August 31, 2009, we observed some stabilization in the credit markets. While these developments have been encouraging for the long-term prospects of our business, we continue to face the cumulative and residual effects of the recession on our portfolio companies. As a result, we believe that the logical path is to continue with capital preservation, cash generation and debt reduction. Before turning the call back over to Rick, I would like to briefly touch on two topics. First, the Board of Directors has decided not to declare dividend for the second quarter of fiscal 2010. As a regulated investment company, we are required to distribute substantially all of our net taxable income to shareholders through the payments of dividends. For fiscal 2009, in order to avoid federal income tax, we must declare dividends equal to $6.3 million or $0.76 per share by November 15, 2009, and pay such dividends by February 28, 2010. The Board will consider declaring a dividend prior to November 15. Subject to certain conditions we are permitted to make distributions to our shareholders in the form of shares of our common stock, in lieu of cash distributions. Second, the June 30, 2009, borrowing base violation became an event of default on July 30. Our lender has elected not to accelerate the obligation to-date, but has reserved the right to do so. We continue to discuss possible solutions to the event of default with our lender. I will return later with a review of our portfolio, but I would now like to turn the call over to Rick to review our second quarter financial results.

[Richard Allorto Jr.:]

GSC Investment Corp’s net loss for the second quarter ended August 31, 2009 was $16.1 million or $1.94 per share. Our net investment income was $1.1 million or $0.13 per share, and our net loss on investments was $17.2 million or $2.07 per share. Our net asset value per share was 691 at August 31, compared to 885 per share at May 31. Our total investment income for the quarter was $3.7 million, a decrease of approximately $2.1 million versus the second quarter of fiscal 2009. Our investment income was comprised of $3.1 million of interest income, $517,000 of management fee income associated with the investment in the CLO and $64,000 of miscellaneous bank interest and fees. The decrease in total investment income versus the second quarter of fiscal 2009 is primarily attributable to an increase of $1.3 million in the allowance for impaired loans and bonds, a reduction of $700,000 in the income from the investment in the GNV CLO, and a decrease in the LIBOR rate earned on floating rate investments between the periods. With the second quarter ended August 31, our total operating expenses before expense waiver and reimbursement were $2.8 million and consisted of $1.4 million in interest and credit facility expenses, $505,000 in base management fees, $342,000 in professional fees, $223,000 in insurance expenses, $172,000 in administrator expenses, and $129,000 in director’s fees and General and Administrative expenses. We recorded $172,000 in expense waiver and reimbursement for the quarter ended August 31, resulting in total operating expenses after expense waiver and reimbursement of $2.6 million. This is an increase in total operating expenses after expense waiver and reimbursement of $226,000 versus the second quarter of fiscal 2009. This is primarily attributable to a one-time non-cash charge of $492,000, stemming from the write-off of deferred financing costs on our credit facility, and the increase in interest and credit facility expenses arising from an increase in the interest rate on our credit facility from the commercial paper rate plus 400 basis points, to the greater or the commercial paper rate and our lenders’ prime rate plus 400 basis points, plus a default rate of 200 basis points. For the second quarter our average cost of funds was 6.1% versus 3.6% for the prior quarter. For the quarter, we reported net unrealized depreciation of $16.1 million. Contributing to this depreciation were $9.9 million in write-downs from our investments in Jason Incorporated, Energy Alloys, USS Mergerco, and [Group Decco], which are all companies experiencing decline in performance prospects and are either in the process of restructuring or have recently completed a restructuring. A $5.9 million net unrealized depreciation in our investment in the CLO equity was primarily due to an increase in the assumed portfolio default rate, a decrease in the assumed recovery rate and a decrease in the assumed prepayment rate in our discounted cash flow model. These changes were made in accordance with current market practice for CLO equity investments, and not as a result of any change in the underlying GNV CLO portfolio. Additional details on the unrealized gains and losses in our portfolio are available in our 10Q and shareholder presentation, which can be found on our website. During the second quarter we made no investments in new or existing portfolio companies and we had $4.6 million in aggregate amount of existing repayments, resulting in net repayments of $4.6 million. On July 30, 2009, an unremedied borrowing base violation in our revolving credit facility became an event of default, which remains uncured to-date. As Seth mentioned earlier, our lender has elected not to accelerate the obligation to-date, but has reserved the right to do so. As a result of the continuing default, the company maybe forced to sell its investments to raise funds to repay the outstanding amount. Such fore sales may result in values that could be less than the carrying values reported in our financial statement. We continue to discuss possible solutions to the event of default with our lender. As of August 31, out total collateral balance of $35.1 million versus $49.6 million of borrowings, yielded a borrowing based efficiency of $14.5 million. The decline in our borrowing base during this quarter is mainly attributable to the decline in the values of the pledged collaterals, and the downgrade of certain public ratings or private credit estimates of the pledged collateral. Due to adverse portfolio events in the GNV CLO, the CLO is not in compliance with certain of its over collateralization tests, and accordingly will not make its next scheduled equity distribution, and will defer payment of subordinated management fees. Available interest spread will instead be used to de-lever and pay down debts of the CLO, until the CLO is in compliance with its over collateralization test. Based upon our current projections, we expect that subordinated management fees will be deferred and equity distributions will be diverted for the next two to four quarters. Now that the portfolio events nor the repayment of outstanding indebtedness constitute a default on the CLO debt. During this time, subordinated management fees will continue to accrue and will be payable in full if and when we are back in compliance with the over collateralization test. That concludes my review. I will now turn the call back over to Seth.

[Seth Katzenstein:]

Thanks Rick. Before we open for questions, I would like to review the composition and performance of our investment portfolio. As of August 31, 17% of our investment portfolio was invested in first lien term loans, 34% in second lien term loans and 27% in senior secured notes, which means 79% of our portfolio was invested in senior secured obligation. An additional 13% of our portfolio was invested in the equity traunch of the CLO that is collateralized by 93% senior secured first lien term loans. We believe that our strategy of investing in senior secured investments increases the probability of meaningful recoveries from troubled investment. Our corporate debt portfolio is diversified with investments among a variety of industries and issuers. As of August 31, we had 41 corporate debt investments in 33 companies across 21 industries, an average portfolio company investment of $2.6 million. At August 31, there were 17 portfolio companies on our watch list, down from 18 in the prior quarter. During the quarter, we added USS Mergerco to the watch list and removed IDI Acquisition Corp, and also exited Blaze Metals in recycling. Subsequent to the end of the quarter, we exited our investment in Event Star Communications, another watch list investment and generated $1.4 million in sale proceeds, which will be used to pay down our credit facilities. To give you a better sense of the portfolio restructuring activity at August 31, 15 portfolio companies were performing with no material restructuring activity, seven portfolio companies had been restructured within the past year, and 10 portfolio companies were actively being restructured. I would now like to update our shareholders on another item of interest. As we announced in May, we have retained the investment banking firm of Stifel Nicolaus & Company to assist us with identifying and evaluating strategic and refinancing opportunities. These discussions are ongoing as we actively consider and evaluate potential past, towards maximizing long-term shareholder value. As you are aware, federal securities laws limit the amount and type of information that we can disclose about such opportunities, but we will provide additional information as events warrant. We remind you, that there is no guarantee that any transaction would be consummated as a result of the Stifel engagement. In closing, I would like to thank all of our shareholders for their continued support and I would now like to open the call for questions. Operator.

[Operator:]

(Operator Instructions) Your first question comes from Greg Mason - Stifel Nicolaus & Co.

[Greg Mason:]

Your non performing and delinquent investments in the Q said its $25.6 million. I assume that’s on a fair value basis. Could you tell us what that is on a cost basis, and then my second question would be actual names; I believe Brown, Blaze and Grant last quarter were on non-accrual, Blaze is gone. Could you tell us kind of what were some of the new names added to the non-performing or delinquent investments?

[Richard Allorto Jr.:]

Sure, I can give you the names. Brown continues to be non-performing. Energy Alloys, Jason, Legacy Cabinets both the first and second lien, targets the second lien, and USS Mergerco. Your first question with the cost, I don’t have that tabulated here, but they are footnoted in the scheduled investments as non-performing.

[Greg Mason:]

Okay, we can look that up. Was there any income recorded from these investments during the quarter or were they placed on non-accrual at the end of the quarter, at the beginning of the quarter; just trying to get a feel for where interest income could go?

[Richard Allorto Jr.:]

Brown defaulted last quarter. The rest of them were placed on non-accrual at the end of the quarter, however, any accrued income through August 31 was reserved 100%, which is why the reserve is $1.3 million.

[Greg Mason:]

But does that mean it did not come through the interest income line this quarter?

[Richard Allorto Jr.:]

There is no income reflected for those names, that’s right.

[Seth Katzenstein:]

On a net basis?

[Richard Allorto Jr.:]

On a net basis, correct.

[Greg Mason:]

And then, of the $1.3 million, is that on a quarterly basis or is that the six-month, year-to-date basis?

[Richard Allorto Jr.:]

The 1.3 is our reserve, that’s really a balance sheet item. It does include a large portion associated with income from Jason Inc. that was probably accrued during Q1. So it is somewhat of a cumulative number, yes.

[Greg Mason:]

Okay, and then on the interest expense going forward, you had the big write off of the deferred financing cost. Assuming the debt outstanding remains kind of unchanged, what should we be thinking about in terms of a run rate for interest expense going forward?

[Richard Allorto Jr.:]

Our percentages, prime plus 400, plus an additional 200 in default rates, today that’s 9.25%.

[Greg Mason:]

Okay, perfect. Can you talk a little bit about the CLO investments? We are under the impression that even though it had kind of stop trapping cash for GAAP purposes, you would still be accruing that income, but it looks like no CDO dividends were recorded all this quarter. Can you talk about what kind of income will hit the income statement on an accrual basis from that investment?

[Richard Allorto Jr.:]

Sure, during this quarter it was a little mixed, because we adjust the effective yield we used to record income at each respective payment dates for the CLO. The last one was in the middle of July, so in the middle of the quarter. So from the beginning of the quarter through July 20, we actually accrued income at 11.2% from July 20 forward. Through the end of the quarter we accrued income at 0.1%. The decrease in that effective yield is a result of decreased in the expected cash flows on a forward-looking basis from the model that we run. So on a forward-looking basis, it is effectively a non-accrual at a 0.1%.

[Greg Mason:]

Okay, and when you say you did accrue a portion during the quarter, does that come through the interest income line or obviously it did not come through the CLO dividend line this quarter. What’s kind of the difference between the income that runs through those two separate line items related to the CLO?

[Richard Allorto Jr.:]

It did go through the interest line. It was not received; therefore it is on the balance sheet as interest receivable.

[Greg Mason:]

The CDO dividends, that’s just separate. Whether you get the cash payment or not is the only way that line item is affected, is that correct?

[Richard Allorto Jr.:]

By dividend, are you referring to the equities distribution?

[Greg Mason:]

On your income statement historically you have CDO dividends, and that was zero this quarter I believe. We can discuss it offline, it’s no problem Rick.

[Operator:]

(Operator Instructions) your next question comes from Peter Carmack - Smith Barney.

[Peter Carmack:]

You guys approached with respect to reorganized equity. I am new to the story here, so you may have talked about this in the previous calls.

[Seth Katzenstein:]

I am sorry Peter. This is Seth Katzenstein. Can you start over at the beginning, you got cut off.

[Peter Carmack:]

Can you guys discuss your approach as it relates to reorganized equity? Some of these are going to go through bankruptcy, and we are probably in a position where we are going to get reorganized equity potentially. Do you guys have any comments on that with respect to whether or not we can hold that or whether or not we would hold that?

[Seth Katzenstein:]

We are sure we are permitted to hold reorganized equity. Pursuant to the borrowing base associated with our credit facility we won’t receive credit for reorganized equity, because it’s set up to be a facility that gives credit for debt security. So in general, our preference to some extent is to maintain debt securities in order to have collateral for our credit facility. However, we are focused on maximizing long-term value. We do our own investments that are going to restructure and reorganize, and in those situations we have to work with other lenders for the companies and put forth programs and proposals that will allow us to maximize our value, and we’ll also make a hold or sell decision at the time the company is reorganizing, and hopefully we will do that in a manner which will allow us to maximize value for our shareholders.

[Operator:]

(Operator Instructions) With no further questions in queue, I will turn the call back to Seth Katzenstein.

[Seth Katzenstein:]

All right. Well, thank you operator. I would like to thank everyone for joining us today, and we look forward to speaking with you next quarter.

[Operator:]

Ladies and gentlemen, that does conclude today’s teleconference. Thank you all once again for your participation.