BCP Investment Corp (BCIC) 2011 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Kohlberg Capital Corporation second quarter 2011 earnings conference call. An earnings press release was distributed earlier today, Monday, August 8, 2011. 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, August 8, 2011. 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 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 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 the Company's second quarter 2011 financial results. I will open the call with some broad commentary about our activities during the quarter, as well as our financial performance. 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 second quarter financial results and performance. We will then open the line up for your questions at the end of the call.

Before I get into the financial details, let me provide a brief recap of our year-to-date activities so as to give context about our current performance and our future prospective growth. As you may recall, we repaid in full the outstanding balance of our secured credit facility on January 31, 2011. In addition, we also received a settlement payment of $2 million from the lenders which we recognized in the first quarter of 2011.

Then, in mid-March we issued $60 million worth of convertible notes. As a result, throughout the second quarter and into the third quarter, we have been focused on utilizing the proceeds of the convertible debt issuance to increase our investment portfolio of debt securities. Throughout the rest of 2011, we will continue to evaluate our equity and debt financing options which will allow us to focus on continued balance sheet growth, increasing net investment income and dividend distributions.

I will now present some second quarter financial metrics and commentary. Our June 30, 2011, net asset value per share was $8.52. For the six months ended June 30, 2011, net investment income was $0.35 per share as compared to $0.13 per share for the first half of 2010. Net investment income for the three months ended June 30, 2011, was $0.13 per share as compared to $0.01 per share for the second quarter of 2010. The Company declared a dividend of $0.17 per share for the second quarter of 2011 and $0.34 per share year-to-date.

Our earnings for the second quarter are just above what we projected, such that our net investment income has covered our dividend distributions year-to-date. We expect that as we further utilize cash and ramp up with new portfolio investments, our net investment income will increase to meet or exceed prior quarterly results. As such, we believe we will see growth in our quarterly dividends by year end.

For the six months ended June 30, 2011, KCAP had $13.6 million of total income as compared to total income of $14.3 million for the same period of 2010. Our KDA-managed CLOs continued to perform well, with quarter-over-quarter increases in their distributions to us. All KDA-managed CLO funds continued to make their distributions to the junior securities we hold as investments and all senior and subordinate management fees are being paid to KDA on a current basis.

The management fee stream paid to KDA is based on the par value of the assets managed and thus, provides a relatively stable income stream not subject to potential volatility in the market prices of the underlying assets being managed.

This stable income stream allows KDA to make periodic distributions to us in the form of a dividend. In the second quarter of 2011, KDA made a distribution to us of $650,000. It is anticipated that Katonah Debt Advisors will make further dividend distributions of current and accumulated earnings to the Company during the balance of 2011. Additionally, as of June 30, 2011, KDA had approximately $1.9 billion of assets under management.

On a side note, at the end of July, the class action securities case filed against the Company was dismissed. Dayl and Mike will elaborate further on some of my comments, and now 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 first half of the year and then review our portfolio of middle market corporate loans and equity investments and our new origination activity. As a result of our activities in paying off the senior secured credit facility in January, which Chris mentioned, we were able to sell some lower yielding assets and also had some other lower yielding assets repay, which resulted in an increase in our net spread.

In addition, we continue to see repayment of lower yielding assets at par which will allow us to further increase our net spread as we invest these proceeds in higher yielding assets.

In addition, as we entered the second quarter of 2011, we also had the proceeds from the $60 million of convertible notes offering available to invest in higher yielding assets. The proceeds from the issuance of these notes will primarily be invested in mezzanine and other junior securities, which will further increase our net spread and be accretive to our NAV.

As we have stated in our past, in 2007 and 2008, we were reluctant to invest in a significant portion of our balance sheet in junior securities because of what we believed were excessive leverage multiples, and in many cases, inflated EBITDA due to a strong economy. Today, both leverage multiples and EBITDA levels are lower, so therefore, we believe that the risk return profile of middle market mezzanine and second liens is much more attractive.

That being said, as always, we will continue to be focused on credit quality and will manage and monitor our risk appropriately. As Chris noted, our June 30, 2011, NAV per share was $8.52, which compares to $8.21 at the end of 2010.

As of June 30, 2011, the weighted average yield on par value of our income-producing loan and bond portfolio was approximately 8.9%, as compared to 8.6% at the end of last year. The yield on our loan and bond portfolio, coupled with our overall CLO portfolio that is yielding over 20% on fair value, provides a reasonable net interest spread before factoring in any distributions that may be made from Katonah Debt Advisors.

Our two largest CLO fund investments, Katonah 10 and Katonah 2007-1, represent 81% of our total CLO investments and 87% of KDA-managed CLO investments, and they are currently yielding an average return of 22% on fair value.

As of June 30, 2011, our weighted average mark on our debt securities portfolio was $0.83 as compared to $0.70 at year end. As far as CLO portfolio, our weighted average mark was $0.75 as of June 30, 2011, a slight increase from $0.74 weighted average mark as of -- at December 31, 2010.

CLO equity positions in our CLO investments rarely trade or privately trade and thus, it is typically difficult to obtain any market rate indicator for these positions. As a result, we establish a fair value, using a discounted cash flow model utilizing market inputs. Again, this policy is unchanged from previous quarters.

Our 100% ownership of KDA was valued at approximately $42 million based on its assets under management and prospective cash flows as of June 30, 2011. Our total investment portfolio at the end of the second quarter of 2011 was $254 million.

Looking at the composition of our investment portfolio, our loan quality continues to hold up well. At the end of the second quarter, our debt securities totaled approximately $113 million and represented about 44% of the investment portfolio. Since the end of the quarter, we've made an additional $12 million of new investments. First lien loans represent 28% of the debt securities portfolio and second lien loans represent 58%. Approximately 7.1% of our investments are fixed-rate investments with a weighted average yield of 12.9%.

During the second quarter, we wrote off one of our debt security positions that had a cost basis of approximately $11 million, but had been written down to a fair value of $250,000 at the end of last quarter. At June 30, 2011, we had four issuers on non-accrual status, representing less than 1% of total assets. As of June 30, we had approximately $40 million of cash which we primarily used to fund new investments, and as I mentioned earlier, approximately $12 million of that has already been utilized.

Our origination activity has slowed over the summer, but we still have two term sheets outstanding which we hope to move forward on soon. Given the highly competitive environment and our rigorous credit process, there is no guarantee that any of these potential new deals will materialize. As an example, one loan we committed to, and hoped to close in July, did not occur because the equity sponsor in our sales could not get comfortable with certain risks in the transaction that were uncovered in diligence.

In another case, we committed to a transaction, but lost to another lender willing to be much more aggressive in both structure and pricing. We expect these trends to somewhat moderate as the market starts to pull back a bit in the near future.

And now, I'll ask Mike to walk you through the details of our financial performance. Mike?

Thank you, Dayl. Good afternoon, everyone. For the quarter ended June 30, 2011, we reported net investment income of approximately $2.9 million or $0.13 per share compared to approximately $300,000 or $0.1 per share for the second quarter of 2010. In each of the first and second quarters of 2011, we paid a dividend of $0.17 per share or $0.34 per share year-to-date. Out year-to-date net investment income of $0.35 per share has more than covered the dividends paid so far in 2011. We had anticipated the volatility in our first two quarters of net investment income and opted to keep our dividends stable throughout the course of 2011.

As previously mentioned, we continue to utilize cash for higher yielding investments and we expect that our net investment income will increase to meet or exceed previous quarterly results in the next couple of quarters of this year.

Our total investment income for the quarter ended June 30, 2011, was approximately $6.3 million as compared to approximately $7.4 million for the same period in 2010. The decrease in the Company's investment income is primarily due to a decrease among investment balances as a result of paying off our senior secured lending facility in the first quarter of 2011.

While we have since been ramping up our investment portfolio following the issuance of $60 million of convertible debt in March, average loan investment portfolio balances outstanding of $290 million for the six months of 2010 remain far higher than that relative to 2011, which had an average loan investment portfolio balance of $118 million.

For the first three months ended June 30, 2011 and 2010, approximately $3.6 million and $2.4 million of investment income were attributable to dividends earned on CLO equity investments respectively. The increase in income attributable to dividends earned on CLO equity investments is due to the enhanced financial performance of such investments and their result of distributions to us. Specifically, last year at June 30, 2010, approximately 13% of our total CLO fund securities at fair value made no distributions to us. Here in 2011, nearly 100% of total CLO fund securities were making distributions to us. Given that our CLO portfolio has an average remaining term of approximately eight years, we expect to continue receiving significant equity distributions from our CLO investments for many more years to come.

Katonah Debt Advisors made no dividend distributions in the first quarter of this year. In the second quarter, Katonah Debt Advisors made a distribution of $650,000 to us and we expect that Katonah Debt Advisors will make further dividend distributions of both current and accumulated earnings to the Company during the remainder of 2011.

Expenses for the quarter ended June 30, 2011, totaled approximately $3.4 million as compared to approximately $7.1 million in 2010. Expenses for the six months ended June 30, 2011, totaled approximately $5.7 million as compared to approximately $11.5 million in 2010. The decrease in expenses for the first half of 2011 relative to 2010 is primarily due to a significant decrease in interest expense due to lower average outstanding borrowings in 2011.

Additionally, there was a significant decrease in professional fees in 2011 relative to 2010 of approximately $2.9 million that was incurred in 2010 related to litigation previously initiated by the Company against its lenders and the Company's restatement of prior period financial statements.

Net realized and unrealized losses for the three months ended June 30, 2011, were approximately $2.0 million. However, year-to-date, we had net realized and unrealized gains of approximately $2.6 million. In the second quarter, previous unrealized losses were recognized as realized losses upon the sale of one of our CLO fund security positions and the write-off of one of our debt security positions. The net impact to NAV was negligible and these assets prior [par] values were already written down to levels close to their ultimate realized values in the second quarter.

I will now move on to recap and discuss our balance sheet. At June 30, 2011, our total investment portfolio of $254.3 million represented approximately 98% of total assets. During the second quarter, we sold one of our CLO fund securities that is not managed by KDA. Specifically, we sold our position in Katonah 4 at a price of $43, compared to our first quarter value mark of $42 and our year-end mark of $29.

Although CLO positions infrequently trade, we have seen some limited trades in the same securities we hold over the past few months, and such trading levels have been close to our mark fair values. As CLO equity positions are difficult to value, since they lack an active market, the limited activity we occasionally do see has validated our valuation methodology for these assets. As previously noted, our CLO fund security holdings are currently generating well above a 20% annual return on fair value.

Our liabilities consisted of $60 million from the convertible debt issuance, and approximately $3 million payables for open trades for the purchase of investments that had not yet settled at quarter end.

At the end of the second quarter, our asset coverage ratio was 424%, which is well above the minimum 200% requirement for a BDC. Our net asset value at quarter end was $194.6 million or $8.52 per share. At June 30, 2011, we had accumulated undistributed net investment income of $4.9 million, or approximately $0.21 per share, a portion of which represents the second quarter dividend declaration of $0.17 per share which was paid on July 29, 2011, to shareholders of record as of July 8, 2011.

In determining the dividend for the second quarter, considerations included the estimated quarterly net income, anticipated net income for the year, the timing and amount of interest and dividend distributions from investments, and the sustainability and smoothing out of the dividend for future quarters.

The aforementioned discussions on the second quarter of 2011 results are also discussed in our recently filed quarterly report on Form 10-Q and our annual reports on Form 10-K, which are available at our website www.KohlbergCapital.com or at www.SEC.gov.

And with that, we'd like to open up the call back to the Operator to start the Q&A session. Operator?

Okay. (Operator Instructions). Okay. And we'll take our first question coming from Troy Ward. Troy, Please go ahead with your question.

Great, thank you, and good afternoon, gentlemen. Dayl, can you tell us real quick, KDA, I know you had $650,000 dividend up this quarter, none the first quarter. Can you tell us what the accumulated earnings are at KDA that have not been dividend up?

I'm going to actually let Mike answer that question since he probably has that number more readily available than I do.

I know for the year so far, we have $850,000 of net income. We have some accumulated distributions from prior years. I don't have that number immediately handy though.

Is the $850 net of the $650 that's already been paid up?

No, that's what their earnings was so far this year.

Okay. So in the first -- so there was $250 or $200,000 that was not dividend up?

That's correct for this year and keep in mind, the first quarter of 2011 for KDA has got higher expenses, so it's not necessarily representative of a normalized performance for KDA.

Could you break that out then into Q1 and Q2? What were the -- what was the performance?

I don't have that handy right now, though I believe if you look at the first quarter 10-Q versus the second quarter 10-Q, I believe that's disclosed.

Okay. Okay. And then one of the things -- you sold off Katonah No. 4, which you said wasn't managed by you. could you remind us just which of the CLOs that you hold are -- are there any others that aren't managed by you?

Yes. There's Grant Grove and then there's Katonah 3 and Katonah 5. All the rest are managed by KDA.

Okay, right. And then you talked a little bit about, Dayl, about the metrics in your portfolio. Can you just talk about the underlying EBITDA in your portfolio, what you're seeing there and how you feel currently about the economic trends?

When you say underlying, are you talking about just the portfolio trends overall or --

Yes, I'm sorry, yes.

Well, I think we've seen certainly for the first half of this year, we've seen pretty stable, steady performance. We have a couple that -- names that are performing extremely well relative to 2010. We have some others who are a little bit under, but I would say for the portfolio as a whole, it's been pretty stable. I think the current environment may have an impact on that going forward, but again, we don't have a lot of heavily cyclical names in the portfolio at this point.

Okay. And then on the new deals that you're doing, I think you said you'd done 12 million the subsequent quarter. What are the coupons you're seeing on your new origination?

I think on the mezzanine, it's around 13%. We also did some other first lien investments, sort of more temporary investments, and those are in single-digits, but still high-single-digits. So I think overall, probably the yield on the new stuff in the second quarter is probably around -- probably in excess of 10%.

Okay. And one last one -- as you think about the fair value on your CLOs, how much -- obviously, using a discount rate when you come up with that fair value. Did that -- how much variation have you had in that discount rate if you think back over the last couple of years and where are you now compared to kind of what was the high level of the discount rate you took in your fair value?

I'm going to let Mike answer that, but I'm giving you sort of a context for that. When you do a valuation of a CLO security, there are a lot of different variables, including the discount rate. To some extent, the discount rate has less impact than some of those other variables. Some of those other variables that are very important are default rates, recoveries in the event of default, how long it takes you to get a recovery once a loan is defaulted and your reinvestment rate. And I would say those have a tendency to be a much bigger driver of overall value of the CLO necessarily than the discount rate is, and those have moved around probably more than the discount rate has, but Mike can give you more detail on that.

Now, that's exactly right, Dayl. The discount rates have moved from -- if you look relative from two, three years ago to today, obviously, today, the discount rates have dropped a bit, but your biggest sensitivities, as Dayl mentioned, are going to be with your default rates, your prepayment rates and your recovery rates primarily and also the timing of recovery. In the grand scheme of things, if you did a sensitivity on the discount rate, I mean, there would be some movement, but it's not as significant as changing the other variables in the model.

As you broadly think about the fair value or the volatility in fair value of the CLO investments, would you think they would have more stability, let's say this time around, if we're headed to something where we start to see volatility in asset marks again because they're seasoned a little bit more? Can you just give me a little color on how you think the CLO investments would potentially perform versus how they performed, let's say, over the last two years?

We actually have E.A. Kratzman, who manages our -- the CLO, so I'll let him answer that question for you.

Yes, hi, Troy.

Hey.

I think if you look at the portfolios and the CLOs today, you'll see much more seasoned loans. Certainly the investments that have gone into the funds in the last year or so have been much lowly levered than in the past. Certainly the default rates are diminimus right now. I think the annual default rate is less than 1% and our CCC baskets are well, well down in all the funds, as compared to where they were back in the '08-'09 period. So as we -- if we do enter another financial downturn, hopefully not as bad as we saw last time around, the funds are certainly positioned very, very well, I would think.

Great. Thank you, E.A.

Okay. Thank you. (Operator Instructions). We'll take our next question from David Chiaverini from BMO Capital Markets. David, Please go ahead.

Good afternoon. Any update related to submitting an application with the SBA to form an [SBIC]?

There's no real update. I mean, it's something we've discussed, but we haven't really discussed much in terms of -- well, it's public in terms of what we're doing, but it's something we're considering.

And compensation expense was about 50% higher than usual in the quarter. What was behind that and can we consider this a new sort of run rate level going forward?

No. That was an anomaly. There were some bonuses paid out in the second quarter related to a lot of work that people had done over the course of 2010 in terms of working through the restatement and a lot of extra time and hours that were put in, and those bonuses were paid in the second quarter of 2011. So I think that -- I don't know what the total of that was, Mike, but that was probably about $0.02 a share, about $400,000.

Maybe just a little bit less, I believe.

Yes. So that was a one time.

Okay. And my last question is related to KDA and I know how there's a $2 million annual tax goodwill amortization. When looking at the number for KDA, the pretax income of $420,000 this past quarter, does that include $500,000 of goodwill or is that before that?

That would be inclusive of it. The cash flow number that you have there would be inclusive of the goodwill, so it's taking that into account.

Okay. So that -- so on a cash basis, it's closer to $900 to a million?

Oh, no, it -- I'm sorry. Effectively, there is no taxable -- I mean, KDA hasn't eaten into that full $2 million of goodwill in the first half, so effectively, that's not a tax -- I mean, it's a tax-effective number, but it's not a tax effective number because there's that cushion there from the goodwill. Effectively, KDA had paid no tax in the first half of 2011.

Okay. So thinking -- if I think of that $2 million goodwill amortization and assume that it's $500,000 per quarter, that $420,000, should I think of that as before --

That is fully sheltered by the goodwill.

Yes, okay. Okay. Thank you.

Thank you. And we'll take our next question coming from J.C. Rogers from Janney Montgomery Scott. Please go ahead.

Thank you. Good afternoon, guys. A quick question for you on credit availability. What are you seeing out there in terms of credit availability, either a line of credit or another form of financing for on-balance sheet investment? And then alternatively, potentially, warehouse lines of credit, if you're looking to ramp up investment to start a new CLO, if that market opens up and becomes more attractive for you.

Well, I think both of those are more readily available now than they were a year ago. That being said, we have not been overly aggressive in pursuing a line of credit at this point because we do have significant liquid assets and we (inaudible) more than enough to fund our near-term investment needs. And that being said, we have had discussions with a number of credit providers and we're certainly pursuing all those and certainly there's much more interest in lending, or at least there was until recently. There was much more interest in lending against financial assets than there were even a year ago.

And in terms of warehouse lines for potential new CLO issuance, those are also available, but I think we're being very cautious in terms of what the terms of those warehouse facilities look like. We don't want to put a lot of additional risk into that where there's substantial mark to market risk in those warehouses, but assuming you're willing to put up a significant amount of equity, warehouses are available for the CLO issuance from probably a very small handful of underwriters.

Okay, great. In terms of -- obviously, there was a lot of CLO issuance earlier in the summer at pretty attractive rates. I was wondering if you have a sense now. Obviously, there's been a lot of volatility over the last several weeks. I wonder if you had a sense as to what the institutional appetite is for CLOs, particularly the senior and the triple-A tranches.

Well, from what we've been told by underwriters is there's still a fair amount of demand out there for triple A's, double A's, single A's, going down the structure. I think pricing on the triple A's, at least until maybe a week ago -- and I don't think we have any update over the last week -- but up until a week ago, continued to be at around the same level they've been through sort of starting in, I guess, late may, early June, sort of LIBOR 120 to 125.

I think the more junior securities, the triple B's and double B's, have widened out from where they were maybe two months ago but again, they're a very small portion of the structure. So I don't think it's really had a big impact on the overall cost of capital for those structures and we will sort of -- obviously, it's something we'll watch very closely in terms of what actually gets priced over the coming weeks to see if that demand is still there.

Okay, great. And one last question -- do you have a sense as to private equity sponsors' willingness to do deals? Obviously, there's again, with recent uncertainty, are you seeing private equity sponsors pull back or they continue to pursue deals and visit -- do you think M&A stays strong? Do you have a sense as whether they stay strong through the end of the year?

Well, it's very hard to look prospectively at the M&A market. I think the market, certainly the first seven months of this year has been very strong on the middle market. I think, as we talked a little bit about, it's picked up quite a bit since the beginning of the year. And it slowed a little bit over the summer, which is sort of a natural from what we've been told by investment banks. There's a fairly large queue of new M&A activity for the fourth quarter, private equity related, but we'll have to see how that plays out.

Okay, great. Thanks a lot.

Okay. And I'm showing no further questions in the queue at the moment. I would like to turn the conference back to your host for any concluding remarks.

I guess we just want to thank everybody for joining us and we appreciate your continued support. Thank you, all.

Thank you.

Thanks.

And ladies and gentlemen, this does conclude your conference. You may now disconnect and have a great day.