BCP Investment Corp (BCIC) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Kohlberg Capital Corp. third quarter 2007 earnings conference call. An earnings press release was distributed yesterday after the close of the market. If you did not receive a copy the release is available on the Company's Web site at www.KohlbergCapital.com in the Investor Relations section.

At this time all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded today Tuesday, November 6, 2007. This call is also being hosted on a live Webcast which can be accessed at our Company's Web site, www.KohlbergCapital.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 212-455-8316.

At this time management would like me to inform you that certain statements made during this conference call which are not historical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Kohlberg Capital Corp.'s believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that expectations will be obtained. Factors and risks such as those described in the Risk Factor section of our 10-K filed on March 29th, 2007, and sections of our Form 10-Q and other SEC documents filed during the course of the year could cause actual results to differ materially from expectations.

Now at this time for opening remarks I would like to introduce Chris Lacovara, Chairman. Please go ahead, Sir.

Thank you, Stacey. Again we welcome the opportunity to speak with you all this morning and to discuss our financial results and our business activities and our progress in executing our business plan in the third quarter of 2007.

Again, I am Chris Lacovara, Chairman of the Board of Directors for Kohlberg Capital. As has been our practice in previous calls I will begin the call with some general commentary on our balance sheet, investing, and lending activities as well as on our asset management business, Katonah Debt Advisors, or KDA. I will then turn it over to Dayl Pearson, our CEO, who will discuss our middle market investment activities in more detail before turning the call over to Mike Wirth, our CFO, who will then provide a brief recap of our third quarter financial results and additional discussion as to financial performance. Then at the conclusions of our remarks we will open the call to any questions.

To start us off, just a few general notes. Kohlberg Capital recorded a modest decline, about a 4% decline in net asset value for the quarter primarily as a result of the general decline in the trading value of credit assets in recent months. That said, our quarterly earnings and our recently declared and paid quarterly dividend reflected the continued strong performance of our investment portfolio and we continue to see current market conditions as on balance quite positive for the execution of our business strategy. We will talk more about that in a second.

Just a reminder -- probably not necessary for all you on the call -- about the general market environment. As we noted the last time we have seen some spillover from the problems in the subprime mortgage area that is causing a repricing which, for us, is actually a favorable repricing of corporate credit risks.

Just again, a reminder. Neither Kohlberg Capital nor our subsidiary company, Katonah Debt Advisors, has any exposure to the real estate market, either on our balance sheet or in our managed CLO Funds. We do not have any activities in real estate or mortgages or asset-backed securities. So really the impact for Kohlberg Capital as a middle market lender and investor is really indirect at best.

Overall, the tightening of credit and liquidity is a result of events in the mortgage market has resulted in wider credit spreads in the corporate credit markets in which we participate, but to date without any increased default. So effectively we are being paid more for new loans but the performance of our portfolio, the credit performance as Dayl will take you through continues to be quite strong.

A few notes on our third quarter. I will take the two parts of our business -- our balance sheet which comprises the bulk of our investments and our source of our dividend and the Katonah Debt Advisors, the asset managers -- separately.

A few general points. First, as I just mentioned we continue to see very strong credit performance among our portfolio. All of our balance sheet investments are performing. We have no defaults on any balance sheet loan or any CLO investment that we have made.

We are long-term investors. This is a really key point. We plan to realize the value paid for our investments. So mark-to-market losses like those that we have recognized in our third quarter results do not impact our dividend because we hold and expect to hold all these securities to maturity at which point they should be paid at par.

Another point. Just a reminder as a business development company or BDC we are not highly levered. We must maintain a 2-to-1 asset coverage, which is effectively a 1-to-1 debt to equity ratio. So unlike some of the vehicles that have been reported in the press, we don't see any magnification of losses and, again, we haven't had any realized losses through high leverage.

Then lastly our credit facility is a committed facility. It is a five-year formula-based revolver. We have substantial liquidity in it today. As some of you probably noted, we recently increased the facility size to $275 million. So we have more than $100 million of excess liquidity for new investing and lending activities as we sit here today.

In terms of third quarter results on our balance sheet, lending, and investing activities, again the environment has become more favorable because of widening credit spreads which results in higher investment return and more cash flow for our dividend. The loan portfolio middle market primarily secured loans with also some mezzanine. That constitutes the bulk, about 90% of our balance sheet. We added about $60 million of assets during the quarter and improved our gross interest yields to around 10%. Dayl will take you through the increase in our unlevered yield. And again in general we view market as very favorable. With loan spreads from middle market loans widening by as much as 100 basis points from where they were earlier in 2007.

We do have mark-to-market that we have to do so again we took a slight write-down of our net asset value to $14.77 per share as of September 30th. I would note that that fully reflects the market volatility of this summer and as Mike Wirth will take you through the bulk of that write-down, really reflects write-down of the loan portfolio as a result of lower trading values in general for loans and credit assets. There are no defaults tied up in that. It is purely because loans have traded down. primarily because of the overhang of loans from deals that work underwritten earlier in the summer and quite frankly what we are seeing now as that pipeline of particularly large LBO loans is successfully syndicated into the market. Loans over the past month or so have actually traded up substantially which potentially gives us some upside from our Q3 NAV in our loan portfolio.

We do have some investments on our balance sheet in CLO Funds. Again these are CLO Funds. They invest entirely in corporate loans. There is no ABS or real estate activity there. We have a portfolio of about $33 million invested across eight CLOs. Most of them are funds that are managed by our portfolio company, Katonah Debt Advisors. These investments only represent about 8% of our balance sheet and, again, they're not the primary focus of our balance sheet activities which are focused on middle market loans.

These investments, though, are performing extremely well. Generally when we make an investment in securities of a CLO fund, we are targeting low to mid-teens, cash on cash returns. These funds pay their security holders on a quarterly basis. Currently those investments are averaging a 28% cash on cash yield. Again, all paid currently on a quarterly basis. So they actually do augment our cash flow for the dividend as earning assets.

We took a $2.5 million write-down in the portfolio of CLO investments. We have primarily to adjust the values of some of the older funds which are approaching their liquidation date to their underlying net asset values. We are not anticipating any other material valuation adjustments for the balance of the year, since the other funds are quite a ways away from their liquidation dates and, therefore, we value them on a discounted cash flow basis.

As I said most of these funds are managed by our affiliate, Katonah Debt Advisors, so we are actually able to monitor the underlying collateral performance, the performance of the investments of those funds. And that continues to be quite strong with de minimus defaults in the corporate loans and which they are investing. All of those funds were in compliance with all of their covenants and as I said paying cash out on a quarterly basis.

Then the other part of our activities, our subsidiary company or portfolio company, Katonah Debt Advisors. This is our asset manager that manages CLO Funds. It continues to remain quite profitable and after really a pause this summer in rolling out new funds, due to a slowdown in the CLO market, is poised for additional growth in its assets under management as the CLO market recovers.

The Katonah Debt Advisors business ended the quarter with about $2.1 billion in assets under management. That is slightly down from the end of the second quarter. This was due to a decision we made to terminate a middle market fund that we were planning to raise so we had accumulated about $60 million of assets for that funds. Instead of continuing to accumulate assets at the KDA level and rolling out that middle market fund, we instead chose to terminate that effort and then purchase the assets which, again, are middle market loans for our balance sheet consistent with our investment policy.

These have attracted yields. They are primarily senior secured loans so -- an attractive yield and an attractive collateral profile since we sit at the top of the capital structures of the underlying borrowers and they provide some more yield for our balance sheet.

In addition to KDA we have approximately $450 million in assets, primarily senior secured corporate loans, that are "warehouse investments". These are investments we accumulate to seed future CLO Funds. The accumulation of those assets is financed by a credit facility provided from Bear Stearns. We plan to use those assets to seed three new CLO Funds which are currently in the works.

I would remind you all that like all of the debt of the CLO Funds managed by KDA, the warehouse credit facility is nonrecourse either to KDA or to KCAP. It is simply recourse to the assets accumulated in the warehouse.

We recently extended the engagement with Bear Stearns through the end of 2008 to give us time to raise these funds. The corporate loan CLO market continues to be quite viable. Clearly there has been a slowdown because of problems in the ABS market; but there is still demand for CLOs. They are getting raised and we are actually marketing the first of these three plan funds right now with an expected closing for that probably in the next two to three months. And then we would do the other two funds sometime in 2008.

The Last topic I wanted to cover before turning it over to Dayl is capital raises and our liquidity. As I mentioned before we recently increased our committed credit facility from $200 million to $275 million and extended the term for a few more months so we have a full five-year credit commitment there. The outstanding balance at September 30th, the quarter end was $170 million which leaves over $100 million of credit to fund our investment activities. And that comfortably takes us into early 2008 at our current pace of investing.

To supplement this liquidity we may also sell some of the lower yielding assets on our balance sheet and replace them with higher yielding assets, which frees up balance sheet capital to redeploy. So this is effectively another source of liquidity for us. In particular, we have some probably syndicated loans and lower yielding middle market loans that are liquid. And so we can sell those at no trading loss and in many cases, actually, at a trading profit and then redeploy that in other middle market higher yielding loans.

The last point I would make, we do plan to raise additional equity to expand our business. And we -- that's consistent with what we told investors in the IPO. We also understand the benefit to our shareholders of increasing the liquidity of our stock over time through future equity issuances. That said, we are very conscious of where our stock prices and we don't believe that our current stockprice is -- really reflects the net asset value of our portfolio or the successful execution of our business plan to date as reflected in our strong earnings and our growing quarterly dividend. And as a result we currently have no near-term plans to issue additional shares. We have adequate liquidity in our credit facility and in some of the more liquid assets that we can potentially swap out of to fund our growth for the foreseeable future.

On balance as I said we think the environment is very favorable for business development companies because the dividend comes primarily from the interest spread on our balance sheet assets and that spread is widening. So that gives us good momentum for continued dividend growth as we move into 2008 and equally importantly that the performance the credit performance of our balance sheet remains quite strong and we are carefully monitoring that. So we remain confident in our ability to continue to grow the KDA asset management business and grow our balance sheet lending activities as we head into the end of 2007 and into 2008.

With that I will turn it over to our CEO Dayl Pearson, who will take us through our portfolio activities in more detail.

Thank you Chris.

I'll talk first about our investment portfolio. At the end of the third quarter, our debt security totaled approximately $339 million. And in addition to that we had approximately $5 million of equity coinvest spread over in some of those debt facilities. Same companies we have debt facilities out to. Of that $339 million First Lien loans represent approximately 56% and Second Lien loans represent approximately 33%. So 89% of our debt portfolio consists of secured assets. The remaining 11% consist of unsecured loans, bonds and mezzanine investments.

While our First Lien positions at quarter have decreased on a relative basis to total investments, this [lease-risky] asset will continue to comprise over 50% of our loan portfolio. In the current market environment with wider spreads we are actually feeling greater relative value in First Lien loans than in Second Lien and mezzanine. Again as Chris mentioned the First Lien middle market loans have generally widened by 100 basis points or more over what they were in the first half of this year.

Our credit quality continues to be excellent. All portfolio companies are current on all debt service obligations and in many cases are paying down loans at par, even though we may be holding those loans at less than par. We would continue to get payments at par in almost all of those loans.

Debt securities are diversified across 26 different industries and 83 different entities. As we have said, since we started the IPO process last year now we believe in this current credit environment. Diversification is key to risk management.

Our average balance per entity is about $4 million. Our top 10 exposures within our debt portfolio represents approximately 18% of total investments. This is down slightly from 20% at the end of the second quarter.

With the change in portfolio mix, our yield on our portfolio for the third quarter was approximately 4.9% over LIBOR as compared to the original spread of 3.5% over LIBOR in December of last year. Approximately 8.5% of our debt securities are fixed rate and the average interest rate on these is 12.9%.

I [don't] want to reiterate we have no RBS, ABS or any exposure to consumer lending or consumer mortgage loans whatsoever.

In terms of the opportunities, the current pipeline continues to be very strong. It has grown significantly since the beginning of the year and as Chris mentions and as I just mentioned, attractive spreads have been driving and have been making these more attractive to us. However I wanted to comment that structures continue to be excessively borrower-friendly and because of that we continue to turn down in excess of 90% of the opportunities we look at. Unfortunately that -- while the credit correction has impacted spreads, it has not impacted structures as much.

We are continuing to build our investment team and are adding staff as needed as our portfolio grows.

For the nine months ended September 30th, we had net unrealized gains with a difference between cost spaces and fair value at our total investment portfolio of approximately $12 million. Of this amount, $23 million unrealized gains since the beginning of the year and the value of Katonah Debt Advisors and a $3 million unrealized loss and the value of our CLO Funds equity positions which Chris talked earlier.

In addition our debt securities portfolio has an unrealized loss of approximately $8 million, which is primarily a result of the general reduction in trading values of loans and bonds as a result of the credit crunch. Again we do not think this reflects the credit quality of our portfolio. And we plan in most cases to hold these loans to maturity and expect to be paid down at par.

Since quarter end, as Chris mentioned there has been some firming up in the bank loan market. Whether or not this continues for the rest of the year, we will have to wait and see. But clearly we do not see any further deterioration in those trading values.

It is important to note that as of September 30th, all loans held on the Company's balance sheet remains current on interest and principal and all CLO funds in which the Company holds investments maintained their original issued credit ratings on all classes of their securities. And we are continuing to make cash payments to all classes of investors and as Chris said, our CLO investments are yielding approximately 28% cash on cash.

At this point I would like to turn over the call to Mike Wirth, our CFO, discuss our financial results and nuances in further detail.

Thank you, Dayl. Good morning, everyone.

For the three months ended September 30, 2007 we reported net investment income excluding unrealized losses of $6.7 million or $0.37 per share. This net investment income reflects increased interest income from the growth of our investment portfolio of $366 million at the beginning of the quarter to roughly $435 million at quarter end. Total gross investment income which consists of interest dividend and fee income was $10.5 million for the quarter.

The equity and income of our wholly-owned portfolio company, Katonah Debt Advisors, provided an additional $657,000 of revenues for the quarter. Total expenses including interest expense were $4.4 million for the period. Noninterest expense for the quarter was $2.1 million and this consists of compensation expense, professional fees and administrative costs. Our year-to-date ratio of non interest expense to average net assets for the quarter was 2.9% which we expect to decrease in future quarters as we increase the size of our portfolio and reach better economies of scale.

Interest expense for the period was $2.3 million on a weighted average debt balance of $136 million for the quarter. Weighted average interest rate on average outstanding borrowings was approximately 5.6% for the quarter and the Company is in compliance with all of its debt covenants.

The Company's assets debt coverage which for a BDC as Chris had mentioned is limited to be no less than 2-to-1 was approximately 3-to-1 as of September 30th, 2007. For the quarter ended September 30th, 2007, we had net unrealized losses of $11.4 million or $0.63 per share. Net unrealized loss for the quarter was a result of decreases in the market value of our investments. Specifically the decrease in the market value of the Company's corporate loan portfolio during the three months ended of $8 million and a $1.8 million decrease in the value of the Company's investment in CLO Funds. Again this is for the quarter. And a $1.6 million reduction in the value of the Company's investment, Katonah Debt Advisors, due to a 2% reduction in assets under management during the quarter.

As previously noted, the decrease in the Company's investment in corporate loans during the quarter was primarily due to the general decrease in the trading value of such assets as a result of current market conditions in the credit markets.

Our net asset value at the end of the third quarter was $14.77 as compared to $15.39 at the end of the second quarter, and $14.29 at the end of 2006.

During the nine months ended September 30th, 2007, our total debt investment portfolio and fair value increased 75% from year end 2006. Our total investment portfolio at quarter end was valued at approximately $435 million with net unrealized depreciation over cost basis of approximately $12.3 million.

Our Board of Directors who is responsible for determining the fair value of investments retained Duff & Phelps during the quarter to perform certain limited procedures on the reasonableness of the Board's fair value terminations on a selection of its portfolio investments. The assets that we subjected to this third party review are predominantly those investments which are [illiquid] and for which a mark-to-market valuation is not usually easily obtained. As of September 30th, 2007, approximately 27% of total portfolio and 48% of total investments at fair value, for which market quotations are not readily available, were subject to the Duff & Phelps procedures.

Our third quarter dividend of $0.37 per share which was paid on October 26th represents an annual yield of 9.9% on the IPO price of $15. We expect this yield to rise in future quarters as we increase our portfolio at leverage and increase the net income of Katonah Debt Advisors.

The fourth quarter dividend merited the amount of net investment income earned for the quarter ended September 30th, 2007. Kohlberg Capital's distributable tax income is generally its GAAP investment income plus any taxable distributions from Katonah Debt Advisors. As long as our dividend distributions to shareholders do not exceed net investment income and realized gain there should be no GAAP return of capital which would lower net asset value per share.

At September 30th, 2007, we had total liquidity [equally] cash plus available borrowings under the revolving credit facility of approximately $112 million. The aforementioned discussions and third quarter results were also discussed in our 10-Q that was filed yesterday. Our third quarter 10-Q is available at our Web site, www.KohlbergCapital.com, or at the SEC Web site, www.SEC.gov.

This concludes our comments. Once again we thank you for your continued interest and support and we're now ready to open the call to questions.

(OPERATOR INSTRUCTIONS) [Greg Mason] with A. G. Edwards.

Thank you. Dayl, could you shed some light on the [Lehman] credit facility that was pulled and what was of that and who actually took the losses on those assets when you pulled them on balance sheet?

Well, I'll answer the last part of that question first. Kohlberg Capital did not take any losses on that termination of that warehouse. It was a mutual agreement between ourselves and Lehman. Given the state of the CLO market perfectly individual to do middle market CLOs we felt that this would be an extended warehouse period and we really felt that the assets some of those substantial portion of the assets really were balance sheet eligible in terms of returns and credit quality and so, therefore, we decided to take those assets under the balance sheet.

There were some other broadly syndicated assets that did get sold. Again none of those -- we took zero losses on this -- sales.

And can you talk Utah about why have First Lien spreads widened out much more than Second Lien and mezzanine in this type of environment where people are worried about credit? I've heard other BDCs say the exact same thing. Can you shed some light on to why First Liens have widened out so much?

I think both First Liens and Second Liens have widened out and, to a lesser extent, mezzanine. I think the difference relative to the total spread on the First Lien is probably so much greater obviously if you're at [LIBOR] plus 300 to 100 basis points widening is more significant than if you are at LIBOR 600 which is where the Second Liens were. But also I think part of the reason we see the relative value is because again as I mention structures continued to be extremely highly leveraged.

And therefore we feel much more comfortable in that environment being in the First Lien particularly when you can be getting LIBOR plus 400, LIBOR plus 450 or buying those loans in the origination process at LIBOR at 375 with a 3 or 4% original issue discount.

We had rather do that and be much further down in the capital structure and a very highly leveraged capital structure.

And then an additional question on your dry powder. We can see on the balance sheet how much dry powder you have, but what about the senior loans that you said you could trade out potentially more attractive investment? How much of those assets do you think you could move over in the event that the market doesn't really give you credit for your stockprice and you don't want to raise capital here?

I would say that's -- we look at that on a continuing basis. I would say that depending upon trading levels it can be anywhere from $30 million to as much as $70 million worth of loans at any point in time. A lot of those we may not want to trade out for one reason or the other, but if we had to, it could be a significant addition to our liquidity.

And then would you be willing to do an equity rights offering if you were trading below book here or do you want to not do anything below book? Just secondary offerings?

It's a very -- that's a tough question to answer. I think if we found that we had used up all of our available liquidity in our credit line and had executed some of the trades that Dayl is talking about to generate liquidity from balance sheet assets and we were missing wonderful credit opportunities to add to our balance sheet, then obviously we have to look at that option. But we are very far away from that point.

And you know it is very funny, Greg. As Dayl said the market is better in the sense that spreads have widened but it is not better as we think it is going to get because, again, you still see very levered capital structures and so I think we are a ways away from having to make that decision because we are able to continue to be selective and add to our balance sheet with a high level of selectivity with the resources that we have.

But obviously as I said in my comments, we are not never going to raise equity and the rule requires us to do a rights offering if we are below NAV.

And then one last question about your competition. What are you seeing in terms of competition from the hedge funds and CDO funds? And also we've heard from some other BDCs that while those may be going away, the regional banks are coming back into play providing competition. Can you talk about the competitive environment now?

The competitive environment continues to be robust. While there was in the larger of middle market deals, there was competition from CLOs reaching down because -- to get additional yield -- that seems to have gone away. Because the larger market yields have also gone up. But again regional banks continue to be aggressive. A lot of other types of structured vehicles which recently started are quite aggressive as well. So there's certainly plenty of competition.

That being said, clearly people are being much more disciplined when it comes to spreads. And we have seen in the middle markets syndicated deals the ability to, again, get close to the allocations we'd like to get in transactions.

But you're not seeing much improvement in the underwriting? Did I understand that right?

That's -- in terms of the leveraged multiples and the structures, while some things have gone away such as covenant like which actually it really was never in the middle market very much, dividend recaps seem to have gone away. But again leveraged possible to continue to be in our opinion very high.

(OPERATOR INSTRUCTIONS). [Dean Chosky] with Lehman Brothers.

You mentioned that KDA has about $450 million in assets in warehouse. What are your plans for the next CLO for KDA?

Well there's a little bit of a limit on how much we can talk about it, because these are privately marketed, Dean, but basically these are loans that were accumulated over the course of really the spring and early summer before the credit correction. So while the performance is very strong, they have somewhat lower yields than new loans that are getting done today.

So our plan is to take that $450 million and prospectively spread across the refunds that we plan to do over the next 15 months and then with additional credit purchases raise the average spread and then essentially do a full CLO with each event. So if you think about that $150 -- that $450 million divided by three that's $150 million per fund. We are planning basically three $300 million fund so each fund half would be stuff that's already warehoused and half would be stuff that would be newly accumulated in these new market conditions.

Thanks. And Dayl, you mentioned repayments or prepayments at par? About how much is that or how much do you anticipate over the next quarter or two?

Most of that is scheduled repayments. You know we've had a couple of loans over the course of the last two months pay off early. That's a total of probably $10 million, but again replacing that right now is not particularly difficult. I think most of that is just scheduled amortization payments or excess cash flow payments that are documented in the credit agreement. So it is things that we have within our plan. We know are coming forward.

(OPERATOR INSTRUCTIONS) William Mansfield with Millennium.

Just a quick question on your asset management company, Katonah Debt Advisors. How do you do the valuation of that for accounting or book value purposes? Sort of as a general comment.

Sure. Mike Wirth mentioned that the valuation committee of the Board uses Duff & Phelps to review valuations of significant illiquid assets and of course that's the largest illiquid asset that we have. So that one is subject to valuation every quarter and every quarter, the management -- and there's actually a separate valuation committee of the Board of Directors -- prepares a valuation of that and then submits it to Duff for a reasonableness check. The metrics that we use are percentage of assets under management and also a look at forward earnings of the business and we compare those. We do basically a full comparable -- both a trading comparable analysis as well that's a merger comparables analysis to set those metrics.

The metrics that we have been using that sort of the easiest to relate to the numbers that we been talking about is a valuation of about 2.75% of AUM which if you looked at the comps work that we've been using really since before the IPO sits really at the lower end of the spectrum. Which I think is appropriate because it is a relatively small company and again we update that every single quarter.

Terrific. That's it. Thank you.

(OPERATOR INSTRUCTIONS). It appears we have no further questions at this time. I'd like to turn the conference back over for any additional or closing remarks.

I think that's all we had. Again we appreciate your support and thank you all for joining us this morning.

Thank you and once again, ladies and gentlemen, that will conclude today's conference. We thank you for your participation and you may disconnect at this time.