ArrowMark Financial Corp (BANX) 2021 Q1 法說會逐字稿

Welcome to the StoneCastle Financial Corp. Q1 2021 Investor Conference Call. (Operator Instructions) Now I would like to turn the call over to Julie Muraco, Investor Relations of StoneCastle Financial. Please go ahead.

Before we begin this conference call, I'd like to remind everyone that certain statements made during the call may be considered forward-looking statements based on current management expectations that involve substantial risks and uncertainties Actual results may differ materially from the results stated in or implied by these forward-looking statements. This would depend on numerous factors, such as changes in securities or financial markets or general economic conditions; the volume of sales and purchases of shares of common stock; the continuation of investment advisory, administrative and service contracts; and other risks discussed from time to time in the company's filings with the SEC, including annual and semiannual reports of the company.

StoneCastle Financial has based the forward-looking statements included in this presentation on information available to us as of March 31, 2021. The company undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of today, May 13, 2021.

Now I will turn the call over to Sanjai Bhonsle.

Thank you, Julie. Good afternoon, and welcome to StoneCastle Financial's First Quarter Investor Call for 2021. Along with Julie, here with me today is Pat Farrell, our CFO.

During today's presentation, I will briefly comment on the banking industry and the credit markets before commenting on the company. Then I will provide StoneCastle Financial's quarterly results and portfolio review, and Pat will provide you with greater detail on our financial results before we open up the call for questions.

In general, the first quarter 2021 had large money center banks and community banks reporting better-than-expected earnings. Furthermore, industry research continues to show that banks are well capitalized and should benefit from an expansion of the economy. The FDIC also reported that in the fourth quarter of 2020, net income increased 9% across all banking institutions. For community banks, that number was higher as they reported 21% net income growth. During that same period, net charge-off rates across all banks fell nearly 20%.

I also want to point out that in the fourth quarter, bank equity capital increased by 1.9% versus the previous quarter. We have seen this trend continue during the first quarter. A majority of the company's portfolio of community banks have reported their first quarter results.

StoneCastle's community banks portfolio reported net income and deposit growth of 7.1% and 4.6% sequentially during the quarter and 62% and 23% on a year-over-year basis. They also reported average Tier 1 capital ratios at 13.3%, which is up slightly from Q4. Also, StoneCastle's community bank portfolio reported a fourth quarter change in reserves, up 1.2%. And in addition, loan book growth was up 2% from the prior quarter.

During the first quarter, we also saw strong performance in the money center bank regulatory capital space. The company's regulatory capital investments performed extremely well. Several investments were either paying down at par or continuing to amortize ahead of schedule since some of these investments were purchased at a discount. I would also like to point out that regulatory capital yields remain 25 to 50 basis points higher than pre-COVID levels despite most other credit market yields tightening.

Now let me comment on the credit markets. The stimulus packages issued during the height of the COVID crisis, including the proposed infrastructure bill, among other factors, have led to heightened inflation fears. This has contributed to the U.S. 10-year treasury widening from 93 basis points to approximately 160 basis points despite the Federal Reserve signaling that U.S. interest rates will remain low for the foreseeable future. With this uncertainty, the markets may be volatile on the perception of rising rates through the second half of 2021.

Regarding impending inflationary pressures, we believe during an upward trend in rates, the banking sector stands to benefit from higher net interest margin, or NIM, which would positively impact bank earnings. Also, an expanding economy should lead to businesses needing more capital for growth, part of which will be funded from bank loans. This increased bank lending should result in loan book growth, thus positively impacting bank earnings.

In addition, an expanding economy should also lead to a decrease in loan default probabilities. This combination of positive fundamentals, along with resulting growth in bank earnings, should meaningfully decrease the risk premium related to the banking sector overall. Therefore, StoneCastle Financial's underlying investment portfolio will be positioned to reap the benefits of these constructive trends. In addition, our rising rate environment should benefit StoneCastle's portfolio. Since over 70% of the portfolio today is in floating rate securities.

Next, I will cover the origination pipeline. In the first quarter, regional and community banks continue to be active, issuing approximately $1.1 billion of subordinated debt in the primary markets, which was basically flat from Q1 of 2020. In the money center bank regulatory capital market, primary issuance during the first quarter was approximately $800 million, in line with historical activity in the first quarter and down slightly from the seasonally strong fourth quarter.

Of note, during the first quarter, there was a regulatory capital issuance from a well-known U.S. regional bank, a possible start to a new trend. When ArrowMark took over as adviser to StoneCastle Financial, we believe there might be opportunities for expansion of regulatory capital issuance in the United States across regional and community banks. We believe a recent regulatory capital security issuance by a regional bank may prompt other non-money center banks to do the same. In the press release, the bank stated that the decision to enter this market was to proactively optimize its balance sheet and take an innovative approach to capital and risk management to benefit their company, clients and their shareholders.

With StoneCastle Financial's long-term relationships and expertise in the regional and community bank space, we may be in a unique position to take advantage of this expansion across the entire banking industry under the ArrowMark platform.

Now on to StoneCastle Financial's results for the first quarter. We are pleased to report that net investment income for the first quarter was approximately $2.6 million or $0.40 per share. At the end of the first quarter, the value of the invested portfolio was $178 million, flat sequentially. The net asset value at the end of the first quarter was $21.62 per share, up $0.18 per share from the prior quarter.

Now let me turn to the portfolio review. During the first quarter, the company invested a total of $17.5 million in 6 regulatory capital investments. The 6 new investments positively contributed to the portfolio with a weighted average coupon of 9.5% and a weighted average yield to maturity of approximately 8.6%. The majority of the securities were purchased in the secondary market this past quarter. Yields of these new assets remain accretive to the investment portfolio.

During the first quarter of 2021, the company also received proceeds of $9 million from maturing securities and paydowns. At quarter end, the estimated annualized effective yield generated by the investment portfolio, excluding cash and cash equivalents, was approximately 9.35%. This portfolio yield has held stable, above 9%, for 17 consecutive quarters or over 4 years running. Our investment team is positioning the portfolio for the most advantageous risk-adjusted returns available in the banking-related assets with a long-term view of creating shareholder value. Our full schedule of investments can be found on our website.

Before I turn the call over to Pat, I want to point out that at StoneCastle Financial, we believe we are at the beginning of a new credit cycle that will position our company with significant incremental value. We have an economy that is reopening with increased probability of rising rates. This new cycle has potential to positively enhance the entire banking industry's financial performance, which should further reduce the risk profile of StoneCastle's investment portfolio. In short, the fundamentals are in our favor.

Within the investment portfolio, we have always been focused on capital preservation and optimizing risk-adjusted returns. Today, we believe the risk premium of the underlying portfolio will continue to decrease, thus offering investors of StoneCastle Financial exceptional returns given a nearly 7.5% dividend yield, while delivering a portfolio that is majority investment grade.

Since the second half of 2015, we have earned or exceeded our $0.38 dividend, providing consistent performance for our shareholders. Today, the company still offers nearly 500 basis points of incremental yield versus other banking-related income-oriented vehicles. All the while, we continue to deliver consistent and stable investment income, a stable and growing NAV and a consistent annualized portfolio yield of over 9%. We believe the company's stock, whether for an equity or a fixed income strategy, is offering significant value to our shareholders.

Now I want to turn the call over to Pat.

Thank you, Sanjai. As I do each quarter, I will present the financial results by going through the components of the company's quarterly results in detail.

The net asset value at March 31 was $21.62 per share, up $0.18 from the prior quarter. Now on to the breakdown of the NAV components. NAV is comprised of 4 components: net investment income; realized capital gains and losses; the change in value of the portfolio's investments; and lastly, distributions paid during the period. Let's review these components.

Gross income for the quarter was $4.1 million or $0.63 per share. Net operating expenses for the quarter were $1.5 million or $0.23 per share, resulting in net investment income for the quarter of $2.6 million or $0.40 per share. As a reminder, in Q4, we had $0.03 per share of nonrecurring income related to the reimbursement of certain expenses in connection with the transition to ArrowMark. As is the case every quarter, the timing of calls, paydowns and option assignments, if any, impact the income generation of the company.

Realized capital gains and losses in the quarter is the second component affecting the change in NAV. The net realized capital gains from investments were approximately $91,000 or $0.01 per share. Realized gains due to foreign currency transactions were approximately $1.8 million or $0.28 per share. The third component, changes in unrealized appreciation or depreciation of the portfolio, relates to how the value of the entire investment portfolio has changed from the previous quarter end to the current quarter end. For the first quarter, the change in net unrealized depreciation on investments and foreign currency transactions was approximately $860,000 or $0.13 per share. I want to point out that gains and losses from foreign currency hedging activities do not impact our net income.

The fourth component affecting the change in net asset value is distribution. The regular cash distribution for the quarter was $0.38 per share, which was paid on March 25 to shareholders of record on March 18.

In summary, we began the quarter with a net asset value of $21.44 per share. During the quarter, we generated net income of $2.6 million, net realized capital gains of approximately $1.9 million and the unrealized value of the portfolio decreased by $860,000. The sum of these components reduced by a distribution of $0.38 per share, resulted in a net asset value of $21.62 per share at March 31, which was up $0.18 from the prior quarter.

Turning to the valuations for our portfolio holdings. It is worth noting that the vast majority of the portfolio continues to be independently marked. For the quarter, approximately 88% of the portfolio prices or marks reflect a minimum of 2 quotations for actual closing exchange prices. These quotations represent an independent third-party assessment of the current value of the portfolio. This should provide a greater degree of confidence in the company's underlying value versus other publicly traded closed-end funds and BDCs whose portfolios are comprised of assets that do not have readily available market quotations and therefore, self-mark many of the assets in their portfolios.

At quarter end, the company had total assets of $182.5 million, consisting of total investments of $178 million and cash interest, dividends receivable and prepaid assets totaling approximately $4.5 million. Our dividend yield at the end of the quarter was approximately 8%.

Now let me update you on the balance of our credit facility. On March 31, the company had $39 million drawn from the facility or 21% of total assets, leaving $23 million available to draw. Based on regulated investment company rules, we may only borrow up to 33.3% of our total assets. Now I want to turn the call back over to Sanjai for closing remarks.

Thank you, Pat. Now operator, I'd like to open up the call for questions.

(Operator Instructions) Our first question comes from Chris O'Connell with KBW.

So I just want to start off with the portfolio yield this quarter. Came down, I guess, a little bit more than I was expecting given the shift over the past couple of quarters toward the regulatory capital investments, which are typically higher yielding. Can you just walk through some of the dynamics there and maybe based on what you're putting on the books now, where you can see that yield kind of stabilizing going forward?

Sanjai, I'll take that.

Sure. You can start. I'll add if you miss anything.

Yes, that's fine. Yes, this quarter, we had -- one of the big securities that came off was a maturity of young partners, and that was earning a 10.5% yield for us. So that was a big piece that came off. We also had a number of paydowns that also came through on securities that were earning in the 8s to high 9s. We did put on a number of securities, some at 12, 10, 10. But we did have a couple that were in mid-7s or low 7s. So it's just a function of during this period, what we happened to put on.

Overall, in terms of the income, as you know, it's timing of when securities are called or sold. At the end of last quarter, we had a number of securities that were called right at the end of December. So it takes a little time to put all that money to work. Sanjai, do you want to add on?

Yes. I mean the only thing I'd add, Chris, is when I look at our pipeline, it is still holding on to some fairly healthy coupons. So I think the high 9s, low 10s top of spread over a base rate, right? And over the last year, you've probably seen some -- from some of the active trading, too, that we have -- we're trying to optimize the portfolio. But if I were to venture I'd say going forward, our pipeline looks pretty good in terms of kind of asset spreads.

Got it. And the low 7s yields that you were mentioning, was that always being rolling off this past quarter? Or was -- or being put on?

We had a mix. We actually had a -- RESONANCE came off at 7.50%, and we had a -- let's see, we've had a -- Opal, too, came on it at 7.38%. So just -- it's really just a mix. I mean like I mentioned, we did -- we put on $6 million -- $6.5 million that was earning between 10% and 12%.

Okay. Got it. So is it fair to characterize the yield as kind of bouncing somewhere around the 9.50% range or kind of similar to somewhere between this quarter and last quarter going forward, all else equal?

I would -- yes, I would say so.

I agree.

Okay. Great. And then just looking at the outlook here, I appreciate your comments on the overall environment and the potential for some ramp-up from the U.S. based on the regulatory capital securities going forward. I know that given the seasonality dynamics, 4Q is a little bit stronger on those investments and 1Q is usually a little bit of a laggard. The first month or so, if you triple that, seems to be some pretty good origination volumes to kick off 2Q. Is the overall pipeline holding up to what you guys have already put on in the second quarter? And do you think it can kind of continue at that pace as you move through the rest of the quarter?

Yes. The short answer is yes. What we saw even during the -- first of all, just taking a step back, 1Q was a bit of a slow start just because it seems like this year, people kind of took their time coming back through the depths. I'm assuming it's all about COVID fatigue. But however, early part of February, the markets kicked in pretty nicely, and it was really on the secondary side, right? Because new deals ramp up, primary issuance just -- they have to structure, et cetera. So it takes a bit of time. However, fortunately, the secondary market was active.

And then from there, we have seen a pretty healthy mix as of today between kind of what we are seeing in the primary market, and we are seeing in the secondary market. And I would guide that it's going forward for the balance of this quarter and early part of next quarter, you'll probably see the same mix in terms of new issue versus secondary.

There are no further questions. I would like to turn the floor over to management for closing comments.

Yes. Stacy, I'll just probably give another few seconds here to see if there's any other questions coming through. Yes. I think we have Chris back?

Chris O'Connell?

Just was hoping to follow up a little bit. Kind of a small item, but was just wondering what the dynamics were around the other fee line, as in like miscellaneous fees. And it seems like it dropped off to one of the lower levels that you guys have seen recently and maybe some of the drivers around that?

Sure. The other income was -- that reimbursed in last quarter, was the reimbursement that we have related to the transition to ArrowMark. So we had a reimbursement that came in last quarter as a onetime item.

Okay. I mean it seems like the run rate even prior to last quarter, though, was close to kind of just over like double where it came in this quarter. Is this kind of the new run rate for that line item, or was there anything else kind of dragging that?

No, that will -- this will be the new run rate for there.

Okay. Got it. And then in terms of just maybe a little basic overview. Could you just walk me through, again, just exactly what the foreign hedging strategy is and how that runs through? You get the financial statements each quarter.

Sure. So each -- what we do on a quarterly -- on a monthly basis is the PMs will look at the amount of securities that are in euros or pounds or whatever currency we happen to have and then hedge that for the month. At the end of the month, they'll close out that position. And as a result, you'll see this quarter, we had some big gains there, $1.8 million, $1.9 million in currency gains this quarter.

The other side of that then is that the portfolio of securities, some of them go the other way. So the value of those decreased, and that's the whole purpose for doing the hedge. All those transactions flow through on the income statement on the statement of operations separately, and those are all laid out right there. So the $1.675 million for realized gain loss on the contracts and then translations, et cetera, but everything flows through separate line items there. Is that helpful?

Yes, absolutely. And so those are being fully hedged. Is that correct?

Yes.

(Operator Instructions)

Okay. And with that, thank you, operator. And to everyone, we look forward to meeting you soon. And please enjoy the start of summer here soon. Have a great evening.

Thanks, everybody.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.