BCP Investment Corp (BCIC) 2009 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Kohlberg Capital Corporation first-quarter 2009 earnings conference call. And earnings press release was distributed on Friday, May the 8, 2009. If you did not receive a copy, the release is available on the Company's website at www.KohlbergCapital.com in the Investor Relations section.

At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (Operator Instructions).

As a reminder, this conference is being recorded today, Monday, May 11, 2009. This call is also being hosted on a live webcast which can be accessed at our Company's website, 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 212-455-8300.

At this time, management would like 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 and sections of our Forms 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. Chris, please go ahead.

Thank you. And thank you all for joining Kohlberg Capital for a review of our first-quarter 2009 financial results.

I will open the call with some general comments about the financial performance of our middle-market lending and asset management businesses. I will then turn the call over to Dayl Pearson, our Chief Executive Officer, who will discuss our investment portfolio in more detail. After that, our Chief Financial Officer, Mike Wirth, will provide a recap of our first-quarter financial results and performance. We will then open the line up for your questions at the end of the call.

For the Company's first 2009 fiscal quarter, net investment income for common share was $0.32, a decrease compared to $0.49 per share for the first quarter of 2008, though equal to net investment income of $0.32 per share for the immediately preceding fourth quarter of 2008.

Net investment income after giving effect to realized losses during the quarter equaled $0.23 for the quarter. Realized losses of $2 million or $0.09 per share were the result of the sale of certain assets below their original cost and were not the result of defaults on loans in our investment portfolio. We sold these assets to ensure our compliance with the maximum leverage ratio permitted under our credit facility. We are in compliance with this covenant ratio, and such asset sales should not be necessary in future quarters as our leverage continues to decrease from regular principal and interest collections.

Kohlberg Capital declared and paid in cash a dividend for the first quarter of $0.24 per share compared to our fourth-quarter dividend for last year of $0.27 per share. As these figures indicate, we continue to maintain our core strategy of funding 100% of our dividend with net investment income without a return of capital. Also, it is important to note that our net investment income is primarily net interest spread income, which we receive quarterly in cash, and that we do not heavily rely on PIK interest or on capital gains to pay our quarterly dividends.

Net asset value per share was $11.53 at quarter end as compared to $11.68 per share as of December 31, 2008. Trading values in the loan market have improved in recent months, and we believe that the downward pressure on our NAV as a result of the distressed market conditions we saw in 2008, has moderated significantly.

Although we were able to maintain our net investment income for Q1 equal to that of the previous quarter, the decrease in our 2009 first-quarter net investment income from the first quarter of 2008 is indicative of the continuation of several challenges facing our company and the BDC sector in general as a result of current market conditions.

First, with our stock currently trading at a substantial discount to our net asset value, it is not possible or advisable to raise new capital which we could otherwise invest at what are currently very attractive interest spreads to grow our dividend. Also, with our credit facility in amortization, which I will discuss in a moment, we had to sell a limited amount of assets in Q1 to ensure our compliance with the maximum permitted leverage facility. Although, as I stated previously, asset sales to reduce leverage should not be necessary in future quarters.

Second, while the credit performance of our loan portfolio remains relatively strong and we have not experienced any realized credit losses to date, the economic recession currently underway poses challenges to the continued performance of some of our investments. Approximately 1% of our loan portfolio is on non-accrual status, resulting in a modest decrease in interest income during the period. And some of our portfolio companies face increased default risk in the coming fiscal year.

Third, some of our portfolio of investments in the subordinated debt and preferred stock of collateralized loan obligation or CLO Funds continue to face some challenges in the current recessionary environment. These challenges relate primarily to investments in CLO Funds raised and invested prior to the onset of the credit crisis in late 2007, which represent approximately one-third of our total CLO investment portfolio and less than 4% of total assets. Although the CLO Funds in which we invested continue to experience manageable default rates and strong net interest cash flows, we saw a significant number of rating downgrades in the underlying loan assets in Q1, particularly in the older CLO Funds, although the pace of such downgrades has decreased significantly in the past few months.

Increased rating downgrades in some CLO Funds have caused some of these funds to temporarily suspend distributions to junior securities and divert payments to the high-rated bond classes in order to delever these CLOs. In such cases, the delevering of the CLO temporarily reduces the current income for KCAP as equity payments are reduced or suspended. However, providing that actual defaults remain reasonably low and that the underlying assets continue to amortize or pay off at par, cash distributions to the junior securities should resume at some point in the future and the affected CLO investments will still generate an attractive overall return.

Our investments in the Katonah X and Katonah 2007-1 CLO Funds, which represent the bulk of our CLO investments, fortunately have experienced much less significant ratings downgrades. The annualized returns on a cost basis for these two CLOs based on their most recent quarterly payments are 40% and 20%, respectively.

Turning to KDA, as of March 31, 2008, KDA had $2.1 billion of assets under management, slightly up from the fourth quarter of 2008, primarily as a result of continued asset growth at the Katonah Scott's Cove credit find. Our 100% ownership of KDA was valued at $56.1 million based on its assets under management and prospective cash flows, up from $54.7 million in the fourth quarter, primarily due to an increase of approximately $20 million of assets under management.

KDA produced a net loss for the first quarter of 2009 of approximately $270,000. KDA made no distributions to KCAP during the first quarter of 2009 as compared to a $350,000 distribution recognized as investment income in Q1 of 2008.

Moving on to the balance sheet, at quarter end, we had debt outstanding of $245 million under our secured credit facility at an interest rate of 85 basis points over commercial paper. Since the end of the first quarter, we have further reduced facility borrowings to approximately $238 million. The credit facility is non-recourse to KCAP and is secured by approximately $311 million of assets at current estimated fair value, consisting primarily of senior secured loans and representing approximately 57% of our growth investment income. The remaining $184 million of our assets, representing 43% of our growth investment income, are unfledged and outside of the credit facility.

In late September 2008, the Company was notified by the lenders that the liquidity banks providing the underlying funding for the facility did not intend to renew their liquidity facility to the lenders. As a result, the facility entered a two-year amortization period during which all principal and net interest collected from the assets pledged as collateral for the facility are used to amortize the facility through a termination date of September 29, 2010. There are no fixed required amortization requirements during this two-year amortization period. However, the Company is required to comply with a maximum leverage covenant. The Company was in compliance with this covenant at quarter end and continues to be in compliance to date in 2009. To ensure compliance with this covenant for Q1, the Company sold approximately $5 million of assets, generating most of the (technical difficulty) loss realized in the quarter.

Because our debt balance will continue to amortize in future quarters through principal and net interest collections on pledged loans, we expect our leverage ratio to continue to improve. We are currently in negotiations with the facility providers with respect to an amendment which would suspend the requirement to use interest and principal collections on pledged assets to repay borrowings and would extend the term of the facility.

And with that, I would like to turn the call over to Dayl, our President and Chief Executive Officer. Dayl?

Thank you, Chris. I will start with some highlights of the quarter and then review our portfolio of middle-market corporate loans and equity.

At 3/31, our net asset value on a dollar basis was approximately $248.7 million or $11.53 per share, down from $250.3 million or $11.68 per share at the end of the fiscal year for 2008. As with most BDCs and other financial stocks, our stock continues to trade at a significant discount to our NAV. These relatively low valuations represent an overall concern about credit quality in the current recessionary environment.

Our policy of being the most diversified BDC by both issuer and industry was designed with this recession in mind and we believe is responsible for our relatively strong credit performance to date. We believe the diversity of focusing on less cyclical industries will benefit us in the ongoing recessionary environment.

We ended the quarter with total assets at fair value of $496 million, a decrease of approximately $27 million relative to year end 2008. The decrease is attributed to lower asset valuations and the fact that we are in the process of delevering, as Chris mentioned, and thereby using principal repayments on our investments and selected sales to pay down our credit facility.

I would just like to mention that we continue to receive normal amortization payments, as well as prepayments. In the first quarter we received $8.3 million of payments at par. Subsequent to that, in April, we received another $1.7 million, mostly of unexpected prepayments, and for the month to date from May, we received another $1 million in just one week.

Net unrealized losses increased by approximately $7.4 million during the first quarter. Unrealized losses on corporate securities and equities, our middle-market portfolio, increased approximately $1.5 million to $41.8 million during the first quarter despite the fact that portfolio companies continue to amortize their prepaid loans at par, as we mentioned earlier.

In the first quarter, we also recognized a $7.2 million net unrealized loss on our investments in CLO securities, bringing our total unrealized loss in such investments to $16.9 million. These unrealized losses were somewhat offset by a slight increase in the value of KDA and for the growth of Scott's Cove.

Now looking at the composition of our portfolio, our quality of portfolio continues to hold up well. At the end of the first quarter, our debt securities totaling approximately $362 million and represented about 76% of our investment portfolio. As in the past, first lien loans represent the largest percentage of our debt securities portfolio, 55%, little change from the end of the fourth quarter. Second lien loans represented approximately 35% of the portfolio, also little change from fourth quarter.

Similar to last quarter, secured debt of our portfolio accounted for approximately 89% of our loan portfolio. By industry, our middle-market portfolio remains very diversified across 26 industries with very little exposure to construction, real estate, retail or finance.

The debt securities portfolio comprises 85 issuers with an average loan exposure per issuer of approximately $4.2 million. Excluding our investments in Katonah Debt Advisors and the CLO securities, our 10 largest portfolio companies represent 17% of portfolio at fair value. As a reminder, by design, we avoid concentration in any one industry or issuer and we have a very active portfolio monitoring program. At March 31, 2009, the weighted average yield on the loan and bond portfolio was approximately 6.5%. Approximately 8% of our debt securities are fixed rate and the approximate average fixed rate is now 11.9%.

As we noted earlier, credit quality remains relatively good. As of 3/31, our hard watchlist increased from 7 to 8 issuers as compared to year end, and that comprised 4.1% of total assets. As of March 31, 2009, five of these issuers representing less than 1% of total assets were behind on their debt service obligations and on nonaccrual status.

Currently, there is very little activity in the primary market as our private equity partners are facing their own constraints in accessing capital and secondary market investments are not offering attractive returns.

And now I will ask Mike to walk you through the details of our fourth-quarter and full-year performance. Mike?

Thank you. Dayl. Good morning, everyone. Starting with our income statement, first quarter 2009, we reported total investment income of $7.1 million as compared to $8.8 million in 2008. Total investment income for the first quarter was $10.1 million, for which approximately $7.4 million was interest income from our debt securities investments and $2.6 million from our investments in CLO Fund securities.

As compared to the immediately preceding fourth quarter of 2008, total investment income declined approximately $1.2 million, primarily due to lower interest yields on the portfolio. Total expenses were approximately $3 million, nearly half of which related to interest expense on our lending facility. Total expenses decreased by $2.5 million from the first quarter of 2008, due to lower interest rates and outstanding balances under our credit facility, as well as approximately $0.7 million reduction in operating expenses equal to $2.71 on an annualized basis.

Across the board, expenses for the first quarter of 2009 are less than those for the same quarter of the prior year, as well as the immediate preceding quarter due to expense reductions in compensation, professional fees and general and administrative expenses.

Net investment income and net realized gains and losses for the quarter was $5.1 million or $0.23 per share. For the first quarter, we declared a $0.24 dividend, which was paid in cash on April 29, 2009 to holders of record as of April 8, 2009. This first-quarter dividend of $0.24 was covered by the Company's net investment income of $0.32 per share and nearly fully covered, inclusive of realized GAAP losses.

Net unrealized losses for the fourth quarter were approximately $7.4 million or $0.34 per share. This consists of approximately $1.5 million in decreased fair value of our corporate securities and equities, reflecting market conditions, and a decrease in fair value of our CLO equity investments of approximately $7.2 million.

Moving on to the balance sheet at quarter end, we had debt outstanding of $245 million under our secured credit facility at an interest rate of 85 bips of the commercial paper. Weighted average interest rate on weighted average outstanding borrowings was approximately 2% during the first quarter compared to 5% in the first quarter of last year and 3.7% from the fourth quarter of 2008.

Our debt facility continues to be in a two-year amortization period, during which all principal and net interest collected from the loans pledged as collateral for the facility are used to amortize the facility through a termination date of September 29, 2010. During this amortization period, the interest rate will continue to be based on prevailing commercial paper rates plus 85 basis points; or if the commercial paper market is at any time unavailable, prevailing LIBOR rates plus an applicable spread. This committed rate is well less than current market rates or at new rates should we renegotiate our facility.

For example, our all-in interest rate last month was less than 1.6%, and as a result, net spread income as a result of lower interest costs for the period is quite favorable. Nonetheless, we are currently in negotiations with our existing lenders with respect to an amendment to the facility, which would suspend the sweep of interest and principal payments on pledged assets and would extend maturities of the facility, albeit at potentially higher cost of funds.

Between cash on hand, liquid investments, the net income on assets not secured by the facility, we anticipate that we have sufficient cash and liquid assets to fund normal operations and dividend distributions in the near future. Since year end, the facility has amortized down to approximately $238 million. Total assets at quarter end were $495.7 million. The stockholders' equity or net asset value was $248.7 million.

As a percent of total assets, debt liabilities outstanding was approximately 50% of total assets or equal to an asset coverage ratio of 201%.

For determining covenant compliance on our facility, the leverage ratio covenant of at least 1 to 1 must be maintained based on the ratio of facility outstanding balance in the most recently stated GAAP stockholders' equity balance as the facility outstanding balance determination date. The Company continues to be in compliance with the leverage covenant ratio based on March 31, 2009 and continuing into the current period.

The aforementioned discussions of first-quarter results are also discussed in our 10-Q that will be filed today. Our past quarterly 2008 10-Qs and our 2008 annual 10-K are available at our website, www.KohlbergCapital.com or at www.SEC.gov.

With that, I would like to turn the call back to the operator to start the question-and-answer session. Operator?

(Operator Instructions). John Hecht, JMP Securities.

Thanks very much for taking my questions. I just wanted to go a little bit into the CLOs on the KDA segment. First of all, can you give me the -- what was the cash flow from the most recent CLO that I know began cash flowing late last year?

For the first quarter it was a little over $1.4 million.

Yes.

Okay. And can you explain the delevering requirements associated with these ratings downgrades and when you might expect these I think the '07, the '07 and other pools just to begin cash flowing again?

In simplest form, when the total amount of loans in the underlying funds reach a certain percentage at CCC rating or below, the funds are required to delever by taking cash that would otherwise be paid out to the junior securities and applying it to some of the other rated classes. And so in order to get the cash flows turned back on to the junior securities that KCAP holds, you either need to rebuild par values so the denominator increases or you need some of the lower-rated assets to be re-rated at higher levels. Now, how long that is going to take in light of the current recession, it's very difficult to predict. But as we look to the current year, we are not budgeting that any of those investments, which, as I mentioned, tend to be our smaller investments, will necessarily start to cash flow again this year.

The good news, as I think you see, is that the cash flows from the Katonah X fund and particularly the large position we have in the 2007-1 fund, which was really a 2008 fund, more than offset those diverted cash flows. So we really -- we can continue to maintain the CLO cash flows at or above historic levels because of the incremental cash flow we are getting from that large fund.

Okay. And you guys mentioned you are in discussions with your [rider] now to potentially change some terms and extend the amortization. Is there any information you can give to us related to the ongoing discussions? And can you give us a little bit of color on, did these discussions occur in the context of the overall credit markets improving? Or was it really just sort of persistence on your part going back to them and showing your performance?

I think it's all of those factors. To answer the first part of your question, we can't really comment on the details, but the form of the amendment would be similar to what you've seen in other BDCs who have gotten extensions or lifting of the amortization requirement, where there's a trade-off between taking a rate increase and getting the interest and principal diversion, or the principal diversion turned off again so that you have access to those cash flows.

Candidly, we have sort of drawn out the negotiation because as we mentioned in our comments, we are not under the same level of pressure that many other BDCs are because we have significant assets and significant cash flows that are outside the facility. And so we have been somewhat reluctant to take the rate increase since we do have resources outside the facility to continue to operate.

That said, we are certainly aware from a shareholder value perspective that having that cash flow diversion turned off and having access to that has benefits to the shareholders, both by removing some of the perceived risk around our company and also by completely eliminating the need to sell assets at losses as in fact we did in Q1.

And I would just add the major other thing we would want in any restructuring or not restructuring -- negotiating the facility is an extension of the maturity date, which we think is important.

The extension is important because that gives you the ability to really maximize the realized value of the assets over time. And so that's been a very important part of our negotiation.

And I do think, John, to your question, that the lenders see the continued strong performance of the portfolio, the fact that our cash flows both inside and outside the facility remained strong. So I think that has helped the negotiation. But again, we haven't rushed into it because we do have resources, and we are not under quite the same pressure as some of the other BDCs are.

Okay. And on that last point, can you give the high-level statistics about cash flows outside of that facility? I mean what are the percentage of assets that are unhypothicated and what's the margin on those, just to give me a sense?

Sure. Basically the statistics that we cite, there are $311 million of assets outside the facility (multiple speakers) pledged assets, so that represents roughly, in rough terms, 60% of our total assets. But because those tend to be the senior secured loans where we get better advance rates, they are also the ones with the lower spread. So while it represents 60+% of our total assets, it's only about 57% of our gross investment income. And the remaining $184 million of assets, which represent 43% of gross investment income, are unpledged and outside the credit facility.

And that goes to Mike Wirth's comment, that even with the interest and principal diversion on assets inside the facility, we have significant cash flow outside the facility to continue to sustain the dividend as well as to pay our operating expenditures.

And again, that's gross investment income. And again, obviously the diversion is the net investment income after paying the advancing cost on the facility, so --

Which, again, is more than 50% of our expenses. So you really have to look at the net effect since there are essentially the interest expense is also inside the facility.

Yes. Okay, so that would be -- there would be no real offsetting interest expense associated with that pool of loans.

Exactly. Said another way, the 43% of our gross investment income outside the facility only has to cover operating expenses and the dividend.

Yes. Okay, great. Thanks very much for the color.

(Operator Instructions). Greg Mason, Stifel Nicolaus.

Good morning, gentlemen. Could you tell us Katonah III through IX, which of those are trapping cash and which of those are paying?

Katonahs IV, V, VII, VIII --

Trapping cash?

Yes. And IX.

Okay. And could you then tell us how close are Katonah X and 2007-1 close to trapping cash? I think this is the biggest concern in investors' minds. So can you give us some comfort there and some numbers around those two investments?

As we just mentioned, Katonah VII recently had a equity distribution of about $1.4 million, which was 4.5% for the quarter and that was last or two weeks ago. Katonah X will pay this month, the end of this month in May, and we expect an equity distribution on that too. It's a little early to triangulate on the exact number, but we expect X to pay the equity.

How much comfort or how much comfort level is there with the CCC buckets and those two investments? And how rapidly are they filling up? What are the risks with the CCC buckets in Katonah X and 2007-1?

Greg, that's a great question. The CCC buckets are what's driving the performance of these funds. A combination of the increased CCC downgrades from the rating agencies, some of which are justified, some of which are not. In addition to the CCC increases, you have the decreasing prices of the underlying assets. And we saw the full brunt of that in the last quarter of '08 and perhaps the first quarter of this year.

I think what we're seeing now is a moderation of CCC downgrades, combined with an increase, probably about 10 to 12 point increase, in all of assets values in the last month or two. And you overlay that with the fact that the high yield bond market has come back, rallying very strongly, which, as Dayl mentioned, which has created a number of opportunities where we are being prepaid at par on assets that we own at significantly less than par. So I don't want to say the CCC downgrade risk is over, but it seems to have moderated for the time being.

And I would just say --

Moving on to the Katonah asset manager, do the management fees that you receive for managing solo funds, do those stop at some point if the CLOs are trapping cash? And how has that impacted income and valuation for your Katonah investment?

The sub fee -- let me back up.

First of all, Katonahs III, IV and V, we do not manage, so those were just Katonahs VII through '07-1.

Okay.

The senior fees are always paid. The sub fees -- and the pace is really deal-specific, accrue at various rates and will be received when the equity is turned back on, or at the maturity of the underlying fund.

Okay, and what's the typical breakout between the senior fee and the sub fee? Like percentage income of your management fees, how much is from senior and how much is from sub?

Typically it's 15% senior, 35% sub.

That's 15 basis points and 35 basis points. So roughly 2/3 of your fees are sub fees and one third are senior.

Okay, and when you value your Katonah investment, does the fact that some of those sub fees have went away factor into the value there of KDA?

Well, again, they don't go away, Greg. They get deferred. And so, therefore, the impact on the value is the fact that you are receiving those on a discounted form at some point in the future, not today.

And we value KDA -- I mean we triangulate it through various methodologies, one of which is a percent of AUM, as well as discounted cash flow methodologies. So like Dayl said, you anticipate getting those sub fees at some point in the future, so you get slightly lower value.

You get those sub fees before the equity gets [turned] or when the equity gets turned?

Yes, if it gets turned back on or failing that, at the end of the -- at the final maturity.

Okay, great. Thank you, gentlemen.

Having no further questions, I would like to turn the conference back over to management for any additional or closing comments.

We don't really have any additional comments. We would like to thank everyone for participating, and we will talk to you again at the end of the second quarter. Thank you.

This does conclude today's conference. Thank you for your participation.