BCP Investment Corp (BCIC) 2010 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Kohlberg Capital Corporation 2010 Third Quarter Earnings Conference Call. An earnings press release was distributed earlier today. 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. (OPERATOR INSTRUCTIONS)

As a reminder this conference is being recorded today, Monday, November 8, 2010. This call is also being hosted on the 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 me to inform you that certain statements made during the conference call which are not historical may be deemed forward-looking statement 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 Factor 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'd like to introduce Chris Lacovara, Chairman. Chris, please go ahead.

Thank you very much. And thank you all for joining Kohlberg Capital for a review of the Company's financial results for the third quarter of 2010. I'll open the call with some highlights 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 third quarter financial results and performance. We will then open the line up for your questions at the end of the call.

Our September 30, 2010, NAV per share was $8.84. For the three months ended September 30, 2010, net investment income was $0.17 per share, and for the nine months ended September 30, 2010, our net investment income was $0.30 per share. The Company declared, and paid in cash, a dividend of $0.17 per share for the third quarter of 2010.

For most of the third quarter, the Company's net investment income includes the impact of higher interest costs on our credit facility, which resulted from a decision by our lenders to charge default interest, and which we paid under protest while we sought judicial relief. I will comment on the recent resolution of this disagreement with the lenders, which also involved a disagreement about the loan maturity, in a moment.

In addition, the Company's net investment income for the nine months ended September 30, 2010, includes the impact of increased legal, accounting, and valuation professional fees of approximately $4 million, or $0.18 per share, related to litigation and the recent restatement of our year-end 2008 and first and second quarter 2009 financial statements.

KCAP had $8.1 million, and $22.4 million, of total investment income for the three months and nine months ended September 30, 2010, respectively. This compares to investment income of $8.2 million and $26.5 million for the three months and nine months ended September 30, 2009.

The decrease in the Company's investment income is due to two factors. First, our portfolio of investment assets decreased from $443 million at September 30, 2009, to $323 million at September 30, 2010, primarily due to the sale or prepayment of debt securities in which we had investments. However, it is worth noting that over the course of this period, the Company used the proceeds of these sales and prepayments to reduce total indebtedness from $228 million to $137 million as of September 30, 2010.

Second, income from our investments in CLO securities was temporarily depressed due to generally poor conditions in the credit markets, which reduced the ability of the CLO funds to pay dividends on these securities. During 2010, we have seen a substantial improvement in the performance of the KDA managed GLO funds that curtailed payments during 2009, and all but one of them has resumed distributions to their junior securities during 2010.

This improvement is due in part to careful management of these funds by our wholly owned portfolio company, Katonah Debt Advisors, or KDA; in particular, superior credit selection and the avoidance of asset sales at distressed prices during the financial crisis.

Our investments in the Katonah X and Katonah 2007-1 CLO funds, which represent 80% of our total CLO investments and 88% of KDA Managed CLO funds, experienced much less significant downgrades and never suspended distributions. These funds have always made cash distributions to KCAP on a quarterly basis.

The remaining 12% of the KDA managed CLO funds have resumed their quarterly cash distributions to equity. Over all, approximately 94% of our equity CLO investments are distributing cash flows, with a weighted average annual return of 23% to fair value.

Turning to our asset management business, as of September 30, 2010, KDA had $2.1 billion of assets under management and our 100% ownership of KDA was valued at $49 million based on its assets under management and prospective cash flows at September 30, 2010.

During 2009, KDA also was impacted negatively by the performance of its managed CLOs, as three of its managed funds began to defer payments of a portion of their management fees due to rating downgrades on the underlying assets. During such times, these unpaid management fees continue to accrue and remain payable to KDA as these funds come back into compliance with certain financial tests. Now that these CLOs have regained compliance, these previously accrued subordinate fees are being paid to KDA during 2010.

Through September 30, 2010, two of the funds have paid KDA all previously accrued fees; and the third CLO has substantially repaid its accrued fees, with total accrued fees paid totaling $4 million for the period. An additional, and final, $1.2 million of accrued subordinated fees are scheduled to be paid in the fourth quarter of 2010. The Company expects that KDA will distribute approximately $4 million to KCAP during 2010, which will largely offset the impact of KCAP's unusual legal, accounting, and valuation fees incurred earlier in the year.

As of September 30, 2010, our borrowings totaled $137 million and our asset coverage ratio was 246%, well above the minimum 200% requirement for BDC.

In September, we settled the dispute with our lenders which I mentioned earlier in the call. Under this settlement, whereby the alleged maturity date of September 30, 2010, claimed by the lenders was extended to February 28, 2011-- In addition, for the remaining term of the loan the rate of interest reverts back to the original nondefault interest rate of commercial paper plus 85 basis points, or approximately 1.2%, as compared to the default rate of interest of approximately 4.9% we were previously paying.

Lastly, we will receive a settlement payment of $2 million provided we refinance or pay off the loan in full by the extended maturity date. We expect to prepay the balance of the loan fully by the maturity date, with the proceeds of prepayments as underlying borrowers either refinance or are sold, and with the proceeds of sales of loans.

The $137 million borrowing, as of September 30, 2010, was secured by approximately $196 million of assets at fair value. The assets which remain after the loan is repaid would remain on KCAP's unlevered balance sheet to generate interest investment income in future quarters.

As we move forward to the close of the year, we also continue to evaluate debt financing options which will allow us to refinance some or all of the outstanding balance in the credit facility and would provide us with additional borrowing capacity to return to balance sheet growth.

Dayl and Mike will elaborate further on some of my comments. And now I'd like to turn the call over to Dayl Pearson, our President and Chief Executive Officer. Dayl?

Thank you, Chris. I'll start with some highlights of the quarter and then review our portfolio of middle market corporate loans and equity. As already noted by Chris, our NAV at September 30, 2010, was $8.84 per share, down from $9.56 per share at the year-end 2009.

Our valuation process, as it always has, focuses first and foremost on the attributes of the subject asset -- the credit quality, performance, industry, and other unique characteristics of the investment. In determining fair values, we consider any available marks, trading activity levels, and other relevant market data. In addition, we continue to use a credit value technique that discounts contractual cash flows based upon bond spreads and yields for comparable issuers for the specific asset, and then adjust those yields using two market indices to adjust for the priority of the asset. The comparable issuers are chosen using industry and credit considerations.

We also further adjust those discount rates to reflect any amendments or prepayments during the valuation period. As a result, the fair value of our portfolio closely tracks the broader market yields for high-yield and leveraged loans.

As of September 30, 2010, our weighted average mark on our debt securities portfolio was 81. As for our CLO portfolio, for which we are obtaining weighted average yields in excess of 20%, as Chris mentioned, our weighted average mark was 61 as of September 30, 2010.

CLO equity positions in our CLO investments rarely trade or privately trade, and thus it is typically difficult to obtain a market rate indicator for these positions. As a result, we establish a fair value using a discounted cash flow valuation model using market inputs. This quarter, we noted an actual market trade on one of our larger CLO equity positions, which validated our fair value methodology and estimate.

Our total investment securities at the end of the quarter were $324 million. Our debt securities portfolio has decreased relative to prior periods as we continue to delever using principal repayments on our investments as well as selected asset sales.

Looking at the composition of our investment portfolio, our portfolio quality continues to be quite good. At the end of the third quarter our debt securities totaled approximately $190 million, and represented about 59% of our investment portfolio. As in the past, first lien loans represented the largest percentage of our debt securities, roughly 50%. At September 30, 2010, our 10 largest portfolio companies account for approximately 47% of our loan portfolio value.

If we exclude our investments in Katonah Debt Advisors and the CLO fund securities, our 10 largest portfolio companies represent approximately 19% of fair value. As you know, we are diversified by borrowed industry in an effort to mitigate the effects of the ongoing economic difficulties, and this 19% is relatively low compared to other BCCs.

At September 30, 2010, the weighted average yield on our loan and bond portfolio was approximately 5.1%,, with approximately 1.3% of our investments being fixed rate investments.

As we noted, credit quality remains relatively good. At the end of September 30, 2010, our hard watch list consisted of five issuers, and our non-accrual loans also consisted of five issuers.

We continue to see prepayment at or above par, which supports our belief that the unrealized losses currently reflected in our portfolio will not necessarily result in realized losses in respect to those investments. Since the beginning of the year, we have had over $51 million of investment sales and over $61 million of investment payoffs and paydowns. Further validating our fair value estimates, these sales and payoffs combined exceeded the fair value estimates for the quarter immediately preceding their respective resolution dates by approximately $820,000.

As a result of the sales and pay-downs that have occurred so far this year, we have reduced our debt facility outstanding balance to $137 million at the end of the quarter, and below $95 million as of our October waterfall payment, which will occur later this week.

In addition, we have had over $3 million additional paydowns since the end of October, and expect an additional $9 million before year end due to refinancings or M&A activities. Pro forma for these payments, our loan balance would approximate $82 million.

Since the beginning of the settlement term sheet with the banks on September 10 -- the signing of the settlement term sheet with the banks on September 10, 2010 -- we will have paid over approximately $55 million on the credit facility, which will result in an approximate $250,000 increase in our net asset value.

And now I'll Mike will walk through the details of our financial performance. Mike?

Thank you, Dayl. Good afternoon, everyone. For the three months and nine months ended September 30, 2010, we reported net investment income of approximately $3.8 million, or $0.17 per share, and approximately $6.7 million, or $0.3 0 per share. Net investment income for the nine months ended September 30, 2010, was approximately $0.30 per share, compared to approximately $0.71 per share for the same period of 2009.

Our total investment income for the three months ended September 30, 2010, was approximately $8.1 million, as compared to approximately $8.2 million for the same 2009 period. Out total investment income for the nine months ended September 30, 2010, was approximately $22.4 million, as compared to approximately $26.5 million for the same period of 2009.

The most significant driver impacting the decline in investment income for the three and nine months ended September 30 was a reduction in interest income from investments and debt securities. This reduction is primarily due to lower average investment balances on which interest is earned and a slight decrease in average LIBOR relative this year to last year.

The decline in debt securities revenue was offset by cash dividend from our asset manager, Katonah Debt Advisors, of $3 million in the first nine months of 2010 relative to 2009. During the remaining part of 2010, we expect additional distributions from Katonah Debt Advisors as they receive additional cash for accrued subordinated management fees for those CLOs which were previously deferred.

For the three months ended September 30, 2010, our CLO securities dividend income was approximately $2.7 million, as compared to approximately $2.4 million for the same period in the prior year. For the nine months ended September 30, 2010, CLO fund securities income was approximately $7.2 million, a $200,000 decrease from the prior year's nine month ended reported sale of income of approximately $7.4 million.

Expenses for the three months ended September 30, 2010, totaled approximately $4.3 million as compared to approximately $4.8 million for the same quarter ended in 2009. Expenses for the nine months ended September 30, 2010, totaled approximately $15.7 million, as compared to approximately $10.8 million for the same period.

The increase in expenses for the nine months ended September 30, 2010, relative to the same period of '09, is due to increased interest expense and increased professional fees.

As for interest expenses, as previously noted, during select periods of either the nine months ended September 30, 2010, or 2009, we were paying, under protest, a default rate of interest which was nearly four times the rate of interest we should have otherwise been paying. Interest expense was $6.7 million, and $6.2 million for the nine-month period ended September 30, 2010, and '09, respectively.

Professional fees year to date for 2010 have also increased relative to the same period of 2009. We have incurred higher-than-usual accounting, third party valuation, and printing fee expenses of approximately $2.2 million related to the restatement of our year-end 2008 and first and second quarter 2009 financial statements. In so doing, we effectively paid twice, once for the original services and then again related to the restatement, for the financial audits for 2007, 2008, and the valuation services related to 2008.

In addition, we have incurred legal fees with respect to the defense of the class action related to the restatement and have incurred other professional fees related to the SEC investigation. Through the nine months ended September 30, 2010, these fees have totaled over $3.2 million, most of which are covered by D&O insurance.

Lastly, we incurred increased legal fees with regard with our claim and litigation against our lenders of approximately $2.1 million.

Realized losses of approximately $10.8 million, or $0.48 per share, were recognized during the nine months ended September 30, 2010, of which approximately $3 million, or $0.13 per share, was recognized in the third quarter, primarily due to the sale or settlement of certain assets below their original cost. These realized losses are primarily the result of the sale of defaulted or distressed loan assets at or above the prior quarter fair value marks.

On the liability side of our balance sheet, as of September 30, our debt facility had a balance of approximately $137 million. This is a substantial reduction from our year-end debt balance of $218 million, and represents significant delivering of our balance sheet since the beginning of the year. The credit facility is nonrecourse to KCAP and is secured by approximately $196 of assets at fair value, consisting primarily of junior and senior secured loans. These secured assets represent approximately 58% of our total assets and approximately 38% of our gross investment income as of September 30.

The remaining $144 million of our assets, representing 62% of our gross investment income, are unpledged and outside the credit facility.

In mid-September, as mentioned before, we reached a settlement with our lenders whereby, for the remaining term of the loan, through February 28, 2011, the rate of interest reverts back to the original nondefault interest rate of commercial paper plus 85 basis points, or approximately 1.2%. As mentioned, we will also receive a settlement payment of $2 million provided we refinance or pay off the loan in full by the extended maturity date.

This $2 million is not reflected in our current-period financial statements, but will be recognized as income when the outstanding balance of our facility is scheduled to pay off. We are currently in compliance with all terms of the settlement and agreement.

At the end of September, our leverage was 41% and our asset coverage was 246%, well above the minimum 200% required by the Investment Company Act of 1940. Weighted average interest rate on weighted average outstanding borrowings was approximately 5.1% during the nine months ended September 30, 2010.

For the third quarter, we declared a $0.17 dividend, which was paid in cash on October 29, 2010, to holders of record as of October 8, 2010. In determining the dividend for the quarter, considerations included estimated current quarter net income, anticipated net income for the year, the impact of increased legal, accounting, and valuation professional fees related to the restatement, and the related legal and governmental proceedings and a resolution of our dispute with the lenders.

The aforementioned discussions and third quarter 2010 results are also discussed in our recently filed Annual Report on Form 10-K and quarterly reports on Form 10-Q, which are available on our website, www.kohlbergcapital.com, or at www.sec.gov.

With that, I'd like to turn the call back over to the operator to start the Q&A session. Operator?

Certainly. (OPERATOR INSTRUCTIONS) John Hecht, JMP Securities.

Good afternoon, guys. Thanks for taking my questions. The first one relates to the portfolio activity since quarter end. It sounds like you continue to have a lot of repayment and sales of assets. Can you give us a little bit more details with respect to how much of this is repayments versus how much is sales?

And then on the sales, are you still getting bids at or above fair value marks? And can you characterize who the buyers are of these types of securities right now?

Sure, John. The simple way to look at it, I think, is when we signed the term fee-- and again, what you see in the quarter end is not necessarily where we were paid down because of the way the credit facility works. If you got a payment, for example, on September 25 of $5 million, you don't actually repay the credit facility immediately; you have to wait till the next waterfall, which is not actually then until October. So the balance you see at September 30 is actually-- you have to reduce by the cash account, which is probably $21 million--

Yes, that's $20 million at quarter end.

So at the time we signed the term sheet with the banks, we had $137 million outstanding, as I said. And our pro forma number today is about $82 million. So that's roughly $55 million in repayments.

$24 million of that, spread over 12 issuers are the result of asset sales; $31 million of that spread over seven issuers are the result of actual pay-downs. And as I said, when you total all of that, you had a net impact of plus $252,000 to our NAV.

In terms of where we are today, we have been out getting bids on a number of these assets. And I think we do have a lot of bids that are very close to our fair value marks. And I would say, of that sort of $82 million that would still need to be sold, well over half of those are what I would call quite liquid securities.

We tried to focus, actually, on selling some of the more illiquid things early on, especially the lower-yielding illiquid middle market loans, even though they're performing well and they never had any repricing because they never had any amendments. It was L-plus 200 or L-plus 300 with no floors. We weren't really sure what sort of receptivity the market had, but we actually were able to sell those. Probably about $11 million worth of what we sold were those types of loans -- pretty close to where our fair value marks were.

We've been surprised at how much bidding activity there is. Obviously, as you may know, the loan markets are pretty healthy the last few months, so that's obviously helped us out. But very often, these are one-off sales. We may look at doing some more sort of wholesale sale later, but right now we have very healthy bidding activity on what we have.

Okay. Second question is what-- if I heard you right, you still have one more CLO that you expect to be back in compliance. What would the full run rate of the CLO distributions be when everything's back in compliance?

I'd have to say probably around $9 million. We only have one KDA remaining sale that has to turn back as equity distributions. And then we have a couple of the older ones, which are not KDA managed anymore, that will still be turned off. But those are very small numbers and very small investments.

Are all of your CLOs still in their reinvestment periods, or are some of them still have that?

They all are, John. All the ones that we manage.

Great. Thanks for the color, guys.

Sure.

Thank you. Greg Mason, Stifel Nicolaus.

To follow up on the last question -- the one CLO that's still trapping cash -- what are the accrued subordinated management fees that are there that could be unlocked? And do you have any expectations of when you think that will be unlocked from a cash flow perspective, timing-wise?

Definitely. There's only one remaining, and it's-- actually the last waterfall, which was on the third quarter, it paid the majority of its accrued sub fees. It has another $1.2 million of sub fees to pay, which will come in this waterfall coming up later this month. At that point, that particular CLO will have paid back all its accrued sub fees, and we expect an equity distribution in the first quarter for that one.

And then, can you talk about your expectations on kind of an annual basis for all of your management fees on the KDA side? What should those generate, typically, on an annual basis?

Typically they generate roughly around 50 basis points on AUM.

That's the gross fee, Greg. That would be the senior and the sub fees.

(inaudible) KDA.

Okay, great. And then, how much is left at KDA that's available to distribute up to KCAP? Obviously, you have this $1.2 million that's scheduled in the fourth quarter, but how much additional cash is left down there to be dividended up?

We probably have another, I guess $1 million to $1.5 million, which-- I don't know at what point that would be dividended up, but there is some excess cash residing at KDA right now.

And you have to remember, Greg, at these levels, with all the fees turned back on, KDA is cash flow positive, too, and will generate annual additional net fees, net income, to be distributed potentially.

Yes, will distribute annual net income and net cash flow.

Can you kind of give us a range of what that net cash flow is on an annual basis that could be available to you guys?

Somewhere between $2 million and $3 million.

Great. And can you kind of give us a feel for what we should be thinking on the professional fee line in the fourth quarter as well as a normalized basis for next year?

Normalized for next year, you could probably go back to 2009 and that would be pretty close because that's been pretty steady other than this year.

That's right.

Great. And is there going to be any more professional fees in the fourth quarter related to the completion of the restructuring?

There probably will be, but it's not going to be anywhere near what we've experienced in the first nine months.

Okay. And then, one last one -- can you talk about why you had the write-down in the value of the asset manager on the balance sheet this quarter?

A lot of it has to do-- it's a value based on a cash flow model. And as you noted, we had a lot of accrued sub fees at KDA. So those cash flows were in the earlier valuations and those cash flows were coming in very early in the cash flow run. So you had a higher value for KDA at the end-- at the second quarter, for instance, because you had a lot of accrued fees come in all at once during the third quarter. A lot of those accrued fees have now since been paid, except for that $1.2 million that I had mentioned earlier for that one CLO. And so that's one of the main reasons for the decline in KDA value.

Okay, great; that's it. Thanks, guys.

Thank you. (OPERATOR INSTRUCTIONS) And I'm not showing any further questions at this time. I'd like to turn the program back to you for any further remarks.

We just thank you all for joining us; we hope to talk to you next quarter.

Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.