BCP Investment Corp (BCIC) 2007 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Kohlberg Capital Corporation 2007 earnings conference call. An earnings press release was distributed early this morning. 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. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, March 10, 2008. This call is also being hosted on a live Webcast, which can be accessed at our company's Web site, at www.KohlbergCapital.com in the investor relations section under events. In addition, if you would like to be added to the Company's distribution last 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 Corporation believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be attained. Factors and risks, such as those described in the risk factors section of our 10-K filed on March 29, 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.

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

Thank you very much, and thank you all for joining us this morning. As always, we welcome the opportunity to speak to our investors and to discuss our financial results, business activities, and our progress for 2007, which, as I think you all know, represented our first full year of operations at Kohlberg Capital. I will begin the call with some general commentary on our balance sheet, investing and lending activities, as well as on the activities of our wholly-owned asset management business, Katonah Debt Advisors, or KDA. Then I'll turn the call over to our CEO, Dayl Pearson, 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 full-year and fourth-quarter results, and some additional discussion regarding our financial performance. At the conclusion of our remarks, we will open the call for any questions.

In general, Kohlberg Capital recorded a modest 2.5% decline in average net asset value for the quarter, net asset value per share, really as a result of the continued general decline in the value of credit assets in the fourth quarter, again, in line with general market conditions. But our quarterly earnings and dividend for Q4 reflected the continued strong performance of our investment portfolio, and we continue to see market conditions as on balance a positive for the execution of our business strategy.

To start off, just a couple of general reminders about our company and our strategy. First, we are long-term investors, and plan to realize the value paid for our investments. So mark-to-market losses of the kind I just mentioned, while important, do not impact our dividend. That (inaudible) from actual realized losses which would impact distributable cash, but I'm happy to report that to date we have had no actual losses.

Second, a very critical point; we are not highly levered. Unlike mortgage REITs and some other investment entities that you've probably been reading about which are highly levered at 8 to 12 times equity, as a business development company, or BDC, we must maintain 2-to-1 net asset coverage, which is effectively a 1-to-1 debt-to-equity ratio. And this low leverage mitigates the potential effect of default losses. Although again, we have experienced no default losses to date.

The last point, which, again, I think, is very important to distinguish us from some of the companies you may be reading about in the press, is we have significant and stable credit and liquidity. I won't name any companies, but, obviously, there are lots of structures out there that are having trouble, both publicly traded and private funds, because they are subject to margin calls. That's not the case for Kohlberg Capital. As a BDC, our leverage consists of a committed formula-based revolver. Our revolver has a maturity in 2012, so there's lots of room to run. And again, we're not subject to margin calls. And the structure of our credit facility and our credit availability is not tied to market value. So there are no triggers that would require us to repay any of the debt. And again, with the low leverage, we have very substantial interest and collateral coverage. I guess the best example of this is that even in the thick of the credit crunch last fall, we were actually able to expand our credit facility, increased it to 275 million, and actually to push out the maturity for a year to 2012, as I mentioned. So in general, our capital structure is very stable.

Now to our investing and lending activities. First, starting with our middle market loan portfolio; that comprises approximately 83% of our balance sheet assets. On balance, as I said at the outset, the environment continues to be very favorable because widening credit spreads result in higher investment returns, and therefore, a growing dividend.

In Q4 we added approximately $60 million of assets, and our investment portfolio at year-end had an average interest yield of around 9.5%. In general, we view current market conditions as representing a buying and investing opportunity with both better economics and terms. And again, because of the general credit crunch, loan spreads widening in the middle market by as much as 200 basis points, and also the ability selectively to buy performing loans in the secondary market at deep discounts to their par value, as many institutions, investment banks and hedge funds, actually sell those assets at deep discounts.

Second, as I said before, we have a strong quality portfolio of loan securities. More than 63% of our loan securities are senior secured loans, so these are at the very top of the capital structure. And more than 90% of our loan investments are senior secured and/or second lien secured loans, so again, with substantial collateral coverage, which again reduces the risk of default losses.

I think more importantly, over the course of 2007, as we were deploying our IPO proceeds and ramping up our balance sheet, we very actively positioned our portfolio for a recession. I think our management felt, even going back a year ago, that we were late in the economic and credit cycle. So we very consciously, as we made new investments and loans, limited our exposure to economically-sensitive sectors. Dayl will go through the portfolio in more detail, but we're pleased to report that despite the slowing economy and the prospect of a recession, almost all of our approximately 100 borrowers were in compliance with their -- all their financial covenants. We had a few covenant default in Q4, all of which have been insured at this point. And more importantly, all of our borrowers were current on all of their debt service. So while we continue to monitor the portfolio very carefully, because of the way we positioned it, even with the slowing economy, we don't see big problems emerging. And I guess I would also note that all of the risks in our individual credits, we believe, are reflected in our mark-to-market, and therefore, in our net asset value at year end at $14.38 per share. So we have discounted securities where we felt there were risks, and that's reflected in our NAV.

The second part of our portfolio, you probably know that we do have an investment -- a portfolio of investments in CLO securities. Again, as a reminder, these are CLOs. They're loan pools of corporate loans. These are not asset-backed CDOs. We have no exposure to the mortgage or real estate markets whatsoever. So the underlying collateral comprises exclusively corporate loans. And our CLO investments are a modest part of our balance sheet. At year-end they were approximately 6% of balance sheet assets.

At year-end the portfolio was around 31 million invested across eight CLO funds, most of which are managed by our wholly-owned portfolio company, Katonah Debt Advisors, or KDA. These investments at year-end were -- had targeted returns when we made the investments in the mid-teens, but at year-end, due to strong performance in the underlying funds, were actually returning approximately 28% cash yield at the end of the year. So, good contributor to our overall dividend. Almost all of these investments are investments in funds managed by Katonah Debt Advisors, our affiliate. So we're actually able to monitor the underlying credit performance of the loans held in the funds, and that performance continues to be strong. And the underlying loans in those funds have had minimal defaults. And as a reminder, the underlying assets in the funds are primarily senior secured or first-lien loans, so they're very protected against any potential defaults. Although, again, the credit performance has been good.

The last part of our balance sheet is our investment in Katonah Debt Advisors. Again, as a reminder, that's our wholly-owned asset management business that manages debt funds. At year-end, our equity ownership of 100% of Katonah Debt Advisors was valued at about $59 million, which represented the remaining 11% of our portfolio of assets. And a reminder again, KDA manages only corporate loan investments. And essentially, it's a vehicle that receives recurring management fees; it does not itself invest in the funds. So it has no underlying exposure to the funds; it's simply an earning vehicle. And KDA end of the year, very profitable, with a run rate gross fee income of more than $10 million. And as a reminder, after KDA pays its own expenses, the excess fee income is essentially distributable dividend income to Kohlberg Capital to support our dividend.

At year-end Katonah Debt Advisors had approximately 2.1 billion in AUM. That's up from 1.4 billion a year ago, so good growth in both AUM and fees. A post year-end event -- some of you may have seen this in January -- Katonah Debt Advisors was able to close its fifth CLO fund, which is called Katonah 2007-1, because it actually priced in December. And that's a testament to the ability of strong managers with capital backing to continue to get CLO funds done and raised in what is otherwise a very challenging market for CLO managers. That CLO fund will be fully invested at about 315 million, and will increase KDA's fee income in future quarters. Since year-end, and with the closing of that fund, Katonah's AUM has increased by another $100 million, and we expect it to continue to increase over the course of the quarter.

And lastly at Katonah Debt Advisors, there are approximately 280 million in warehoused investments that are financed in a warehouse credit facility with Bear Stearns, which we plan to contribute into two new CLO funds, which Katonah Debt Advisors will bring to market in the balance of 2008. As I mentioned, the market for CLO capital raises is very challenging, and we continue to look at other structures that will allow Katonah Debt Advisors to grow its AUM, and also to take advantage of deep discounts on secondary loan trading in the market.

Two other new platforms I just want to mention. First, in November we announced the formation of Panagos Katz Situational Investing as another portfolio company of KCAP. Panagos Katz is basically a distressed debt manager that will raise the funds that will be managed by that company, but will also generate distressed debt opportunities for the Kohlberg Capital balance sheet, and will also be a source of additional fee income in future quarters.

And then also in January, we announced the acquisition of Scott's Cove Capital Management, which is really being added to the Katonah Debt Advisors platform. Scott's Cove manages a small credit-oriented fund with a long-short strategy, and brings a very skilled team, led by a gentleman named Phil Schaeffer, whose expertise in long-short in credit, and in investing in different types of fixed income, will be very additive for Katonah as we raise some different types of funds in future quarters and in future years. So it was an increase to our AUM, but also bringing on board some good talent that will help us to do some different things at KDA.

Last topic I wanted to cover before turning it over to Dayl is capital raises. As I mentioned, last fall, we were able to increase our credit facility to 275 million. We're effectively fully borrowed at this point, and our equity, as you know, is fully invested. So we, clearly, plan to raise additional equity to expand our business, and we certainly understand the benefit to our shareholders of increasing the liquidity of our stock through future equity instances. That said -- and I think we mentioned this in our last quarterly call -- we're very conscious of the dilutive effect of issuing new stock at substantial discounts to our NAV. And quite frankly, we don't feel that our current stock price really reflects our strong performance. So we're trying to navigate between doing something that would be somewhat dilutive, but also making sure that we raise capital to take advantage of what we think is a very, very favorable lending and investing environment.

Some of you may have seen -- we did file a registration statement for a rights offering. We are continuing to monitor the trading value of our stock in general market conditions. As I said, we are committed to raising capital, but also, I think, looking at the share price, and making sure we do this in a way that benefits the shareholders.

So, I guess, to sum up, on balance sheet -- on balance, the environment is very favorable because most of our dividend comes from the balance sheet spread income, and interest rate spreads are increasing. And as I mentioned, and Dayl will go through this more, our existing portfolio performance remains strong. Clearly, raising new capital in this credit crunch remains challenging at both the Kohlberg Capital and Katonah Debt Advisors levels. I guess in the worst-case, we simply continue to clip coupons both in our balance sheet investments and in the funds that KDA manages, and kind of ride out these stormy markets. But, as I said, we do remain confident in our ability to raise new equity capital at some time, and to continue to grow.

With that, let me turn it over to Dayl, who will take us through the balance sheet performance in more detail.

Thank you, Chris. Let's talk about our middle market investment portfolio. At the end of 2007, we had debt securities which approximated $411 million. I think as some of you know, we have tried to manage this in a very conservative manner. I think three things. One Chris alluded to is we have tried to stay away from highly cyclical businesses as much as possible. Secondly, we've tried to maintain our highly secured portfolio; the further up you are in the capital structure, the higher recoveries you have in troubled situations. And third is our diversity. I'm going to talk about the second two; I think we've already alluded to the first.

Again, as Chris said, first lien loans represented about 63% of our portfolio, with second lien loans accounting for another 28%. So 91% of our loan assets are secured loans, with 63%, almost two-thirds, being the most senior part of the capital structure. We actually increased our percentage of first lien loans in the fourth quarter, and this was because of the fact that the relative spreads on those expanded much more dramatically than the second lien or mezzanine loans did.

Credit quality of our portfolio at year-end was outstanding. All of our investments were current on their debt service as of 12/31. Again, we continue to be very rigorous and disciplined in terms of looking at new investments.

In terms of diversity, we again have investments across 26 different industries and 91 different entities, so our average balance per entity is approximately $5 million. Our top 10 exposures within our debt securities portfolio represent approximately 18% of total investments. I think if you compare that to most of our BDC brethren, that's much more diversified than most.

With the change in portfolio mix as of 12/31, our yield average spread was 4.8% over LIBOR, which is up, obviously, from 3.5% at the beginning of 2007. Approximately 7.3% of our debt securities are fixed rate, and the average rate on those is 12.9%. I want to reiterate we have no exposure to RMBS, ABS, or any consumer lending vehicles.

We expect again to be able to selectively grow our investment book in 2008. As Chris said, at this point, we are fully borrowed, but we continue to have repayments. Those repayments, as we reiterate all the time, continue to be at par despite the fact that many of these securities have been marked down due to the market dislocation.

Our turndown rate remains well above 90%. While spreads are certainly more attractive than they were a year ago, structures still seem to be somewhat more levered than we would like. So we expect that turndown rate to remain very high.

In terms of our unrealized gains and losses, December 31, our net unrealized gains, or the difference between the cost basis and fair value of our total investment portfolio, totaled approximately $5 million relative to 12/31/06. Of this amount, we had a $23 million unrealized gain in the value of Katonah Debt Advisors, and a $5 million unrealized loss in the value of our CLO fund equity positions. Our debt securities and equities portfolio had an unrealized loss of approximately $13 million. This is almost exclusively due to the result of the general reduction in trading volumes for loans and bonds as a result of the credit crunch. Again, we expect and we continue to see most of these loans in bonds pay off at par.

These (inaudible) -- since quarter end, we again have seen some volatility in the loan market, and so there's a chance that we will continue to see some further erosion in some of these marks. But again, we do not expect that to result in realized losses.

It's important to note that as of 12/31, all loans held on the Company's balance sheet remained current on their interest and principal payments, and all the CLO funds in which the Company holds investments maintain their original [issuer] credit ratings on all rated classes of their securities. And all of them will continue to make cash payments to all classes of investors.

Subsequent to year-end, we have seen in January one payment default on a broadly syndicated loan. Our total position on that loan is $2 million. We've clearly seen the impact of the current economic slowdown, and anticipate that we will have further defaults during the course of 2008, but we anticipate that such defaults will be few and will result in very limited losses. We do not really anticipate any losses as of today. Overall portfolio quality remains strong, and again, recognizing that almost two-thirds of our portfolio is in the least risky part of the capital structure, i.e. first lien loans.

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

Thank you, Dayl. Good morning, everyone. I will first discuss our full-year 2007 results, as well as similar benchmarks for the fourth quarter. As this is our first full year of operations, and the financial results for December 31, 2006 covered only approximately two weeks after our IPO, I will not make any comments regarding the comparability of prior-year results to current-year performance, since such a comparison would not be meaningful.

For the full year of 2007, we reported net investment income, excluding unrealized gains, of 25.3 million, or $1.41 per share. For the three months ended December 31, 2007, we reported net investment income, excluding unrealized losses, of 7.2 million, or $0.40 per share. Our net investment income, excluding unrealized losses for the year and for the fourth quarter, exceeded the average consensus estimates both at the time of our IPO in December 2006 and as most recently reported.

Net investment income excluding unrealized losses is also one of the benchmarks used to determine our quarterly dividend. For the fourth quarter of 2007, we paid a $0.39 per share dividend, and our total dividends paid for the year were $1.40 per share. In both instances, our net investment income excluding unrealized gains or losses covered our dividend payments with no return of GAAP capital. We believe an important distinction of the quality of our earnings and the result of the dividend is that they are more dependent on net interest and dividend income rather than on capital gains on sales of investments. We believe that the income stream on interest and dividends is much more predictable, recurring and less volatile than relying on capital gains to earn the dividend, particularly in the current market environment.

I will now highlight the components of our net investment income. Total gross investment income, which consists of interest, dividend and fee income, was 40.7 million for the year and 13.3 million for the fourth quarter. Katonah Debt Advisors, our wholly-owned portfolio company, contributed approximately 3 million to gross investment income for the year.

Total expenses, which includes interest expense, was 15.7 million for the year and 6.3 million for the fourth quarter. Non-interest expense for the year was 8.5 million and 2.6 million for the fourth quarter. Non-interest expense consists mainly of compensation expense, professional fees and administrative costs. Our annual ratio of non-interest expense to average net assets for the quarter was 3.2%, 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 full year was 7.2 million on a weighted average debt balance of 106 million for the year. The weighted average interest rate on average outstanding borrowings was approximately 5.5% for the year, and the Company is in compliance with all its debt covenants. The Company's asset-to-debt coverage was approximately 2-to-1 as of year-end, and consistent with the coverage requirements of a BDC. Our net increase in stockholders' equity from operations for the year, which is our net investment income inclusive of unrealized gains, was 26.1 [million]. As a result, our net asset value at the end of the year was $14.38, compared to $14.29 at the end of 2006.

During the year, our total investment portfolio at fair value increased 103% from year-end 2006. Our total investment portfolio at year-end was valued at approximately 505 million, with net unrealized appreciation over our cost basis of approximately 5.1 million. Our fourth quarter dividend of $0.39 per share, which was paid on January 24th, represented an annual yield of 10.4% on our 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.

As noted before, our net investment income and realized gains sufficiently cover our dividend payments. So long as our dividend distributions to shareholders do not exceed GAAP net investment income and realized gains, there should be no GAAP return of capital, which would lower net asset value per share.

The aforementioned discussions of the fourth quarter and our annual results were also discussed in our 10-K that will be filed in the next couple of days. Our annual 10-K will be available at our Web site, www.KohlbergCapital.com, or at www.SEC.gov. This concludes our comments, and once again, we thank you for your continued interest and support, and we'll now open the call for questions.

(OPERATOR INSTRUCTIONS). David Chiaverini, BMO Capital Markets.

Good quarter and year, given the difficult environment. My first question is on -- regarding the valuation, how much of the portfolio has market quotes available as opposed to internally determining both the valuations?

We have approximately 38%, 39% -- 38%, roughly, that we call level 1, where there are mark-to-market [marks]. This is of the total portfolio, which would include Katonah Debt Advisors and the CLO funds. And of that, level 3 access, which are primarily Katonah Debt Advisors, would be another 24%. But again, for Katonah Debt Advisors and for the CLO funds, there are pretty objective inputs that go into the valuation of those particular investments.

You mentioned in the quarter about how there's plenty of opportunity to buy discounted assets. Did you take advantage of that and get any assets at a discount?

We did, yes, some. We did buy some in the fourth quarter at a discount.

What was the average discount?

None of them were deeply discounted. It was in the mid to high 90s at that point. And again, we did not do a lot of it, just because we didn't have an enormous amount of liquidity.

Where are those loans like the loan market today? Has it deteriorated much from the fourth quarter?

I would say it has been very volatile. It was down substantially in January and February; seems to have sort of stabilized over the last couple of weeks, moved up a bit. But it's very volatile given the lack of liquidity in the market right now.

Regarding the couple of covenant defaults in the fourth quarter, could you give a little more color on that and how you were able to cure them so quickly, and what sort of industries those were involved with?

They were in a variety of industries. And in terms of -- middle market loans have a tendency to have a very full and tight covenant package. And so it's really not that unusual to have covenant defaults, because you really don't want anything to get off sides completely. In two of the cases, the defaults were due to, I wouldn't say substantial, but not insignificant underperformance of the companies. And in both of those cases, the equity sponsor stepped up and put in additional capital, and therefore was able to cure those defaults by reducing leverage back to the levels that we were comfortable with.

Okay. Lastly, what was the run rate of KDA's net income in the fourth quarter?

KDA's run rate for the fourth quarter -- and this would be after-tax -- was 1.6 million. (multiple speakers) that's for the quarter; that's correct.

Between 6 and 7 million. That's why we think we head into 2008 with -- that's up from probably less than half that at the start of 2007, so we head into 2008 with good growth in distributable income at KDA.

Thanks.

John Hecht, JMP Securities.

Dayl, you referred to, I think, about 7% of the portfolio being fixed rate. So in consideration of that, what's happened with LIBOR, as well as widening spreads and incremental assets, where do you guys envision margins going to, and, I guess more specifically on the yield side, things settling out the next couple of quarters?

I think one thing that, while LIBOR has dropped in any amendments that we have and in any new facilities, there's been the reemergence of the LIBOR floor. And generally, the LIBOR floor -- it says no matter what LIBOR is, we never charge less than 3% or 4%; in a couple cases we have a 4% LIBOR floor, and in one case you have a 3.5% LIBOR floor. And on top of that, new deals right now, middle market deals, first lien, are probably pricing around LIBOR 500 at some discount. So really, the overall yield hasn't gone down that much. And remember, 50% of our capital structure at this point is floating rate as well. And that 7.9% fixed rate only refers to the loan portfolio; it does not refer to all of our CLO investments and our investment in Katonah Debt Advisors.

So as you work through this calendar year, establish some more floors, invest more, we should actually potentially see some widening margins?

I think so. It all depends upon how active we are in terms of adding new assets. The loans that are rolling off, obviously -- and we have a fair amount in the first -- anticipated in the second quarter, are all loans without LIBOR floors. So they will be replaced with loans with LIBOR floors, or fixed-rate securities.

Thanks. Have you guys publicly discussed fund-raising goals for Scott's Cove and the PKSI in the coming quarters?

I don't think we've discussed them publicly, so I'm not sure we can really comment. Mike's saying we can comment. Okay. Panagos Katz, I think, is targeting a fund of sort of somewhere 150 to 250 to get started. And they're currently interviewing placement agents. And as I said, they will not only be investing in that fund, in which Kohlberg Capital may potentially make an investment, but also would be generating direct investment opportunities for the balance sheet.

At Scott's Cove, they currently have about 60 million in assets under management, and we do expect to increase that. I think they will benefit from being part of the larger Kohlberg Capital and KDA platform. But in addition, those folks will be very much a part of some other non-CLO fund structures that Katonah Debt Advisors is looking at, some lower levered funds that have a little bit more flexibility in terms of what they can invest in, and are really designed to capture discounted credit assets. So their capital raise may not be -- capital increase may not be that distinct from other funds that KDA itself is raising (inaudible) part of that.

Thanks very much for the color.

(OPERATOR INSTRUCTIONS). [Dean Traski], Lehman Brothers.

Dayl, in your prepared remarks, you mentioned that you anticipate some defaults in 2008, but no losses. Is that more looking out at the market in general, or are there specific securities that you're concerned about? If so, can you provide a watchlist or some sort of risk metric to give us a sense of what the size of the potential issues could be in the portfolio?

We don't really -- we have an internal watchlist, but that's not something we publicly disclose. I would say we're just monitoring our portfolio very carefully. We recently had a full investment committee presentation, and I think our view is that our portfolio is in extremely good shape relative to where the economy is right now. But, obviously, any portfolio of the size we have is going to have some issues, or potential issues. So I think we're just -- I think everyone's going to have some. Defaults are, clearly, going to be up this year across the market. I think they were less than 1% last year, and I think Moody's and the others are predicting it's going to be 4 to 5% this year. We think we will do better than that. But again, most of our loans are fairly high in the capital structure. So we think that these are fairly limited issues from our perspective.

If there is a default or a covenant violation, does that impact your ability to finance it on your credit facility?

If there is a payment default, yes. If there's a covenant violation, no.

You mentioned that you're expecting some repayments or prepayments. Can you throw out a sense of the size of those over the next couple quarters? What do you have visibility on?

What we have visibility on is probably only through the next 45 days, and that's probably around between 9 and $10 million that we know about. We had up -- in January and February, I think we had about 6 or $7 million. And in some cases, they were loans [that were] carrying an 89 that paid off at par. Two that we know that we're going to get prepaid on over the course of the next 45 days we are carrying at par, but they're going to pay off at 101 due to the call protection we have.

Mr. Traski, did you have any further comments?

No. Thank you very much.

(OPERATOR INSTRUCTIONS). There are no further questions at this time.

Thank you all for your time.

That will conclude today's call. We thank you for your participation.