ArrowMark Financial Corp (BANX) 2020 Q4 法說會逐字稿

Welcome to StoneCastle's Financial Corp. Q4 2020 Investor Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

Now I would like to turn this call over to Ms. Julie Muraco, Investor Relations of StoneCastle Financial. Thank you. You may begin.

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 volumes 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 December 31, 2020. The company undertakes no duty to update any forward-looking statements made therein. All forward-looking statements speak only as of today, March 1, 2021.

Now I will turn the call over to Sanjai Bhonsle.

Thank you, Julie. Good afternoon, and welcome to StoneCastle Financial's Fourth Quarter Investor Call for 2020. 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 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 the call for questions.

In general, the fourth quarter of 2020 continued the trend of large money center banks and community banks reporting better-than-expected earnings. Furthermore, we believe banks will continue to be well capitalized. For the most part, banks have adequate reserves in anticipation of any corporate defaults from continued economic uncertainty. The most obvious concerns continue to be the industry sectors, most affected by the pandemic in hospitality, retail, transportation and some parts of energy.

I want to remind our shareholders that the bank investments in StoneCastle Financial's portfolio have underlying loans diversified by industry sectors. Also, community banks within the portfolio primarily service their local markets in real estate, such as multifamily, owner-occupied residential, C&I and other small businesses that have held up well during the past year.

During the fourth quarter, we saw relatively strong performance with most of the company's community banks reporting sequential growth in net income, with fairly stable to upward trending Tier 1 capital ratios. The issuance of new PPP loans help community banks partially mitigate increases in loan loss reserves with some banks partially reversing these increases during the fourth quarter.

To date, a majority of the company's underlying community banks had reported their fourth quarter results with median net income up 16.8% versus the third quarter. In addition, these banks reported average Tier 1 capital ratios of 12.3%, flat from Q3. Finally, our underlying community banks reported a fourth quarter change in reserves, which were up 15 basis points to 1.37%. In general, loan books were flat from the prior quarter.

We also saw strong performance in the regulatory capital sector during the fourth quarter. In this sector, the company's regulatory capital investments performed extremely well with several investments either paying down at par or continuing to amortize ahead of schedule. For the most part, the amortizing assets were purchased at attractive discounts during the market dislocation in Q2. As expected, the regulatory capital investments proved to be resilient during 2020.

For the first half of 2021, our outlook for the banking industry remains cautiously optimistic. We are encouraged by the efforts towards additional government stimulus and other agency programs designed to help the consumer and small business. It is likely that these programs will be distributed through the banks, similar to the first round of PPP.

Now let me comment on the credit markets. In the fourth quarter, the Federal Reserve signal that U.S. interest rates will remain low for the foreseeable future. Recent policy considerations and some reported economic indicators began fueling talks of inflation in the credit markets. Post the U.S. election, through today, we have seen the yield curve steepen for the 10-year treasury. We believe this is due to the factors already mentioned, along with the perception that COVID vaccinations and the stimulus package may result in better economic conditions in the second half of the year. Regarding impending inflationary pressures, we believe during an upward trend in rates, banks should benefit from higher net interest margin, or NIM, which would positively impact earnings.

Next, I will cover our origination pipeline during the quarter. In Q4, the primary markets continue to be active in both regulatory capital and community banking securities. In regulatory capital securities, primary issuance during the fourth quarter was approximately $3.5 billion, which is consistent with a seasonal spike in activity during prior years.

The full year issuance was approximately $9 billion, and our expectation for 2021 remains optimistic. We also believe the secondary markets will continue to be a source for regulatory capital investments.

Community banking originations in the primary market continue to be relatively strong. In Q4, community banks raised approximately $2.6 billion, down from $3.1 billion in Q3. Banks were generally able to issue sub-debt in the 4% to 6% range, similar to the third quarter. The continuation of attractive interest rates should allow these banks to issue sub-debt at historically low rates into the foreseeable future.

Now on to StoneCastle Financial's results for the quarter. We are pleased to report that net investment income for the fourth quarter was approximately $3.1 million or $0.46 per share, an increase of $0.04 per share from the prior quarter or up 11%. The fourth quarter net investment income had a positive impact from other income of approximately $0.03 per share, which Pat will discuss further in his comments.

At the end of the fourth quarter, the value of the invested portfolio was $178.4 million versus $147 million at the end of the third quarter, an increase of 21%, primarily due to the new investments made during the quarter. The net asset value at the end of the fourth quarter was $21.44 per share, up $0.55 or nearly 5% from the prior quarter, including the reinvestment of dividends.

Now let me turn to the portfolio review. During the fourth quarter, the company invested a total of $42.5 million in 7 investments, including $37.5 million in 6 regulatory capital transactions and $5 million in 1 community bank preferred stock. The 7 new investments contributed a weighted average coupon of 10% and a weighted average yield to maturity of approximately 10.4% to the portfolio. The majority of the securities were purchased in the primary market at par.

Yields of these new assets remain accretive to our earnings. Since the transition over to StoneCastle ArrowMark as a new adviser, the company has made $99.3 million of investments, which exceeded the last 2 years combined in terms of gross investment activity. During the fourth quarter of 2020, the company received proceeds of $12.2 million from full call on 2 investments, proceeds of $7 million from the sale of 1 investment and received partial pay downs of $3.7 million from 4 investments for a total of $22.9 million in proceeds.

In the first quarter of 2021, we continue to make new investments, and we'll share more details when we report on our first quarter results. At quarter end, the estimated annualized effective yield generated by the invested portfolio, excluding cash and cash equivalents, was approximately 9.65%. This portfolio yield has held stable, above 9% for 16 consecutive quarters or 4 years running.

Our investment team is positioned the portfolio for the most advantageous, risk-adjusted returns available to us in banking-related assets with a long-term view on creating shareholder value. A full schedule of investments can be found on our website.

Before I turn the call over to Pat, let me close my remarks by reflecting on my first year as Chairman and CEO of StoneCastle Financial. It was just about this time last year that shareholders approved StoneCastle ArrowMark as investment adviser and the current investment team began advising on the assets of StoneCastle Financial. As always, we have continually emphasized managing risk, growing assets, enhancing the dividend and increasing the value of the company.

As mentioned previously, in aggregate, StoneCastle ArrowMark reported total new investments of $99.3 million in assets, despite the volatility of the credit markets and the competition for yield-oriented assets. The Board of Directors declared a $0.05 special dividend, which enhanced the regular cash dividend and offered investors a year-end 2020 dividend yield of just over 8%.

The net asset value of the company grew from reported March 31 Q1 pandemic-related low of $19 to $21.44 per share reported at year-end. Pat will report on the annual performance of NAV, but I particularly want to point out this metric as it speaks to the team's ability to navigate volatile markets and produce solid performance during a challenging year.

I also want to point out to our investors that the breadth and the scope of the personnel who work with management on StoneCastle Financial's investment portfolio and in operations has been significantly expanded with the transition to StoneCastle ArrowMark and the ArrowMark platform. With that, our expertise in banking-related assets across ArrowMark's platform offers a significant and intangible advantage to the company and to our shareholders.

I want to acknowledge my colleagues for their hard work, and I want to thank you, our shareholders, for the steadfast support you have shown the company over the last year. It is much appreciated. I'm excited for what the future holds for StoneCastle Financial and the opportunities to grow the portfolio.

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 December 31 was $21.44 per share, up $0.55 or 4.8% from the prior quarter, including reinvestment of dividends.

Now on to the breakdown of the NAV components. The 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 $4.7 million or $0.71 per share. Net operating expenses for the quarter were $1.6 million or $0.25 per share, resulting in net investment income for the quarter of $3.1 million or $0.46 per share. This compares to $2.8 million reported in the prior quarter, up $0.04 per share. I would like to note, in the fourth quarter, $0.03 per share of net investment income represents nonrecurring income related to the reimbursement of certain expenses in connection with the transition to StoneCastle ArrowMark.

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 $312,000 or approximately $0.05 per share. Realized losses due to foreign currency transactions were approximately $1.6 million or $0.25 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 fourth quarter, the change in net unrealized appreciation on investments and foreign currency transactions was $5.4 million or $0.81 per share and unrealized depreciation on options written of $620,000 or $0.09 per share. I want to point out that gains and losses from foreign currency hedging activities did not impact our net income.

The fourth component affecting the change in net asset value is distributions. The regular cash distribution for the quarter was $0.38 per share, along with a special cash dividend of $0.05 per share for a total distribution of $0.43 per share, which was paid on January 5 to shareholders of record on December 21.

In summary, we began the quarter with a net asset value of $20.89 per share. During the quarter, we generated net income of $3.1 million, net realized capital losses of approximately $1.3 million and the unrealized value of the portfolio increased by $4.8 million. Some of these components offset by a distribution of $0.43 per share resulted in a net asset value of $21.44 per share at December 31, which was up $0.55 or 4.8% from the prior quarter, including the reinvestment of dividends.

The 2020 annual performance of net asset value was down $0.39 per share from $21.83 to $21.44. As Sanjai mentioned, the recovery of NAV throughout 2020 from the March 31 low of $19 to $21.44 at year-end, we believe, speaks to the quality of the underlying credits in the portfolio.

Turning to the valuations for our portfolio holdings. It is worth noting that the vast majority of the portfolio continues to be independently marked from broker-dealer quotes. For the quarter, approximately 85% of the portfolio prices or marks reflect a minimum of 2 quotations or 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 $188.4 million, consisting of total investments of $178.4 million and cash, interest and dividends receivable and prepaid assets totaling approximately $10 million. Our dividend yield at the end of the quarter was approximately 8.2%.

Now let me update you on the balance of our credit facility. On December 31, the company had $43 million drawn from the facility or 23% of total assets, leaving $19 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 the line of Chris O'Connell with KBW.

So just wanted to start off with the portfolio yield. I know you guys mentioned at the end of the quarter coming in around 9.65%. I was just wondering if you had what the average yield was for the fourth quarter?

Pat, do you want to take that?

Sure. I believe we noted that in the press release 9.65% was the number for the quarter.

Okay. Great. And then it sounds like the investments you made during the quarter were coming on around 10.4% yield. Was there any change in that in terms of what the investments were coming on following the quarter end?

You mean for Q1?

Yes. You guys had mentioned that following the end of the quarter. You had made some additional investments, I think, around $13.5 million or so. I'm just wondering if there's any change in that yield versus what was oncoming during the fourth quarter.

Those are also strong, also in the 9s, and I believe we may have a couple of 10s in there as well.

Okay. Great. And then -- so I'm assuming it's safe to say that all new investments are coming on kind of consistent to that level and kind of consistent to what you guys were gearing towards last quarter in the high 9s range. And as far the demand and the growth in the back half of the year, especially in the fourth quarter was really strong, congratulations there. But I was wondering going forward, demand, obviously, following quarter end, also seemed strong. Is it safe to say that given where the sub-debt issues that you guys mentioned in the 4% to 6% range for community bank yields, and in general, community banks are kind of flushed with liquidity right now following some of the Fed actions in 2020. Is it safe to say that the alternative investments will be kind of leading the first half '21 demand, at least as far as you see now?

Yes. So Chris, that should be fairly accurate. You're right, the community bank sub-debt is in the 4% to 6% range. And we are seeing a slowdown of issuance there to begin with here in the new year. And if there's any portfolio churn, you should expect a disproportionate amount of that liquidity being deployed in regulatory capital investments, Q1, Q2, at least.

Great. And then as far as the demand for overall alternative capital investments, has that kind of remained strong so far in 2021?

What do you mean by demand for...

Are you guys seeing -- are you guys continuing to see strong growth in the first half of the year?

Oh, okay. Got it. Yes. So just to -- and obviously, we've talked about this in our previous calls, regulatory capital issuance is a bit seasonal. And usually, Q4 is the strongest quarter. And then Q1 kind of lags that, right?

What we have seen during Q1 is the seasonal adjustment to that. However, the secondary markets and regulatory capital have been fairly active. And so from that perspective, we are seeing sufficient amount of investments that we need to take a look at. And so between the primary market and the secondary market in Q1, it's a healthy amount of investments, again, like I said, to analyze and make a decision on.

Got it. And just given where we are in the quarter, a little bit further than we typically are for this call and update. Is it safe to say also with your comments around the red cap investments being seasonally a little bit lower in the first quarter that the first quarter kind of net investment portfolio growth isn't going to be too much stronger than what was already indicated in the press release? Or do you guys have kind of a late pipeline that's coming through in the back half of this quarter?

Yes. So obviously, I can't give you specific details as to what's going on in Q1. But as mentioned in my previous comments, we did make additional purchases during the first quarter. And like I said, it has been a fairly active quarter both in the primary and secondary markets.

And -- but having said that, you obviously see some investments repay. And timing of that is not always a known quantity, but I'll just kind of mention that we have been active buying new investments here during the first quarter.

The ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to our CEO for closing remarks.

Well, thank you, operator. Again, thank you for your support through a challenging 2020. Please do stay safe and healthy. And I'm looking forward to the time when we can all meet in person again. So thank you, good night, and speak with you all soon.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and enjoy the rest of your day.