BCP Investment Corp (BCIC) 2011 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Kohlberg Capital Corporation third quarter 2011 earnings conference call. An earnings press release was distributed earlier today, Wednesday, November 9, 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, Wednesday, November 9, 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 this expectation 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 Dayl Pearson, CEO. Dayl, please go ahead.

Thank you, and thank you all for joining Kohlberg Capital for a review of the Company's third quarter 2011 financial results. Our Chairman, Chris Lacovara, who usually makes some introductory comments, is not able to join us today. So I will open the call with some broad commentary about our activities during the quarter, and will then discuss our investment portfolio in more detail.

I will then turn the call over to our Chief Financial Officer, Mike Wirth, who will provide a recap of our third quarter financial results and performance. We are also joined on the call today by Al Pastino, our Lead Independent Director, and E.A. Kratzman, the President of Katonah Debt Advisors. Once Mike has finished his presentation, we will then open the line for your questions.

First, 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 senior 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 in convertible notes. Since then 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. At quarter end, we have sufficient liquidity and cash and highly liquid investments by which to make continued higher yielding investments that meet our credit and underwriting profile.

Given the uncertain economic environment and a very volatile credit market, we have remained very cautious in terms of deploying capital and continue to maintain significant liquidity. We also continue to evaluate our equity and debt financing needs, which will allow us to focus on continued balance sheet growth, increasing net investment income and dividend distributions.

I will now briefly present some third quarter financial metrics. On September 30, 2011, NAV per share was $8.29. For the nine months ended September 30, 2011, the net investment income was $0.52 per share as compared to $0.30 per share for the same period in 2010. Net investment income for the three months ended September 30 was $0.18 per share compared to $0.17 per share for the third quarter of 2010 and $0.13 per share for the second quarter of 2011.

The Company declared a dividend of $0.18 for the third quarter of 2011 and $0.52 year-to-date.

For the nine months ended September 30, 2011, KCAP had $20.1 million of total income as compared to total income of $22.4 million for the same period of 2010.

I will now 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 of this year, we took the opportunity to sell some lower yielding assets which resulted in an increase in our net spread. In addition, we continued to see repayments primarily of lower yielding assets at par, which have allowed us to further increase our net spread as we invest these proceeds in higher yielding assets, primarily mezzanine and junior securities.

After a very strong level of high-quality deal flow in the second and early third quarter, the OR level and quality of that flow was significantly less during August and September. As of September 30, 2011, the weighted average yield on the fair value of our income-producing loan and bond portfolio was approximately 8.2%. In addition, the yield on our CLO portfolio is approximately 20% of fair value. So the combined yield on fair value of our total debt portfolio -- loans, bonds and CLO securities -- was 14% in the third quarter.

As of September 30, 2011, our weighted average mark on our debt securities was 83 as compared to 70 at year-end. As far as CLO portfolio, our weighted average mark was 72 as of September 30, a slight decrease in the weighted average mark of 74 at December 31, 2010.

Our 100% ownership of KDA was valued at approximately $43 million based on assets under management and prospective cash flows at the end of the quarter. Our investment portfolio at the end of the third quarter totaled $255 million.

Looking at the composition of our investment portfolio, our portfolio quality continues to hold up well. At the end of the third quarter, our debt securities totaled approximately $121 million, representing about 46% of the entire portfolio. First lien loans now represent 39% of the debt securities and second lien loans represent 43%. Approximately 9.4% of our investments are fixed-rate with a weighted average yield of 12.9%.

At September 30, 2011, we continued to have just four issuers in non-accrual, representing less than 1% of total assets.

Our KDA-managed CLOs continued to perform well, with quarter-over-quarter increases in their distributions to us. All KDA-managed CLO funds continue to make the distributions to junior securities we hold as investments and all senior and subordinate fees are being paid to KDA on a current basis.

The management fee stream paid to KDA is based on par value of assets managed and thus provide the stable income stream not subject to potential volatility in the market prices of the underlying assets. This stable income stream allows KDA to make periodic distributions to us in the form of a dividend. In the third quarter of 2011, KDA made a distribution of $510,000. It is anticipated that KDA will make further dividend distribution of current and accumulated earnings to the Company during 2011. Additionally, as of September 30, 2011, KDA had approximately $1.9 billion of par value assets under management.

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 September 30, 2011, we reported net investment income of approximately $4 million or $0.18 per share compared to approximately $3.8 million or $0.17 per share for the third quarter of 2010. In each of the first and second quarters of 2011, we paid a dividend of $0.17 per share and in the third quarter, we paid a dividend of $0.18 per share or $0.52 per share year-to-date.

Our year-to-date net investment income of $0.52 per share has covered the dividends paid so far in 2011.

Our total investment income for the quarter ended September 30, 2011, was approximately $7.2 million as compared to approximately $8.1 million for the same period of 2010. The decrease in the Company's investment income is primarily due to a decrease among investment balances as a result of our paying off of the 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 $277 million for the first nine months of 2010 remain far higher than that relative to 2011, which had an average loan investment portfolio balance of $123 million.

For the three months ended September 30, 2011 and 2010, approximately $3.9 million and $2.7 million of investment income respectively were attributable to dividends earned on CLO equity investments. The increase in income attributable to dividends earned on CLO equity investments is due to the enhanced financial performance of such investments and the result of distributions to us.

Specifically, last year at September 30, 2010, approximately 6% of our total CLO fund securities at fair value made no distributions to us. During 2011, nearly 100% of the CLO fund securities were making distributions to us. Given that our CLO portfolio has an average remaining term of more than seven years, we expect to continue receiving significant equity distributions from our CLO investments for many more years to come.

In the third quarter, Katonah Debt Advisors made a distribution of $510,000 to us for a year-to-date total of $1.16 million.

Expenses for the quarter ended September 30, 2011, totaled approximately $3.2 million as compared to $4.3 million in 2010. Expenses for the nine months ended September 30, 2011, totaled approximately $8.9 million as compared to approximately $15.7 million in 2010. The decrease in expenses for the first three quarters 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 $3.8 million that was incurred in 2010 related to the Company's restatement of prior period financial statements and litigation previously initiated by the Company against its lenders.

Net realized and unrealized losses for the three months ended September 30, 2011, were $5.5 million. Year-to-date, we have net realized and unrealized losses of approximately $3 million.

During the first nine months of 2011, 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, as these assets' prior [par] values were already written down to levels close to their ultimate realized values during 2011.

I will now move to recap and discuss our balance sheet. At September 30, 2011, total investment portfolio of $254.8 million represented 97% of total assets. During the second quarter, we sold one of our CLO fund securities that was not managed by KDA. Specifically, that was Katonah 4 at a price of 43, compared to our first quarter fair value mark of 42 and our year-end mark of 29.

Although CLO positions infrequently trade, we have seen some limited trade in the securities we hold over the past few months, and such trading levels have been very close to our market 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 consist of $60 million from the convertible debt issuance in March, and an approximate $9 million of payables for open trades for purchase of investments that had not yet settled at quarter end. As of September 30, 2011, we had approximately $37 million of cash, which will primarily be used to fund future investments, a portion of which will be used to pay approximately $9 million of open trade payables, again, for those traded, but not settled, at quarter end.

At the end of the third quarter, our asset coverage ratio was 416%, well above the minimum 200% requirement for a BDC. Our net asset value at quarter end was $189.7 million or $8.29 per share. At September 30, we had accumulated undistributed net investment income of $5.1 million, or approximately $0.22 per share, a portion of which represents the third quarter dividend declaration of $0.18 per share which was paid on October 28, 2011, to shareholders of record as of October 10, 2011.

In determining the dividend for the third quarter, considerations included estimated current quarter 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.

On a side note, in 2010, the Company and certain officers and/or directors were named as defendants in a derivative action and in three class actions related to the Company's restatement of its year-end 2008 and first and second quarter of 2009 financial statements. As previously disclosed in January 2011, the derivative action was dismissed and we were pleased to note that just last month, the class action suits were dismissed with prejudice.

Lastly, the Company is in the process of evaluating whether, in accordance with rules under Regulation SX, the separate financial statements of a totally owned portfolio company, Katonah Debt Advisors, are required to be filed with respect to fiscal year ended December 31, 2010, and if separate summarized financial information for KDA is required to be filed with respect to the quarterly period in fiscal 2011, including the third quarter of 2011.

Because the evaluation requires the Company to perform the test specified under various rules of SX using amounts determined under US GAAP, the Company is required in accordance with ASC Topic 810, Consolidation, to prepare financial statements for KDA for the fiscal year December 31, 2010, on a consolidated basis that will include the assets and liabilities of the CLO funds managed by KDA in order to perform the tests necessary to determine whether separate financial statements and separate summarized financial information of KDA are required to be filed, and if so, whether such financial statements are required to be audited.

While KDA does not have any investment in the CLOs it manages, these CLOs are deemed to be variable interest entities under GAAP, and thus, the assets, liabilities and the operations of the CLOs will be consolidated in KDA's financial statements on an equity basis of accounting.

At this time, the evaluation has not been completed and is ongoing, and the Company has not reached any financial conclusions. However, the Company believes that it is likely that at least one of the conditions specified in SX will be met and thus, the consolidated financial statements of KDA will need to be filed with KCAP's 10-K and quarterly financials.

Most importantly, the Company expects that the inclusions of such separate financial statements and summarized financial information for KDA will not result in any restatement to the previously reported financial results of the Company, including the financial results included in the Company's quarterly report on Form 10-Q for the quarterly period ended September 30, 2011, which was filed earlier today without the separate summarized financial information for KDA.

The aforementioned discussions and the third quarter of 2011 results are also discussed in our recent filings with the SEC, which are available at our website www.KohlbergCapital.com or at www.SEC.gov.

And with that, we'll turn over the call back over to the Operator for the Q&A session. Operator?

(Operator Instructions) Our first question comes from John Hecht with JMP Securities. You may begin.

Good afternoon, guys. Thanks for taking my question. The first one -- I'm wondering if, Dayl, maybe you can tell us about what average rate payment yields were during the quarter and then why you were active investor in the quarter, what type of yields you were able to invest in in the market? And then maybe as kind of a tag-on to that, you mentioned you got a little hesitant at the end of the quarter as things got a little volatile. Is there an update? Have things changed and where are you seeing opportunities today?

Sure. I would say the things that we closed during the quarter, they would fall really into two buckets. One would be sort of our more junior securities. We closed one mezzanine loan which had a yield of, I believe, 13%, and we also closed on a second lien loan which also had a yield of 13%. We also chose to make some other investments in some broadly syndicated lower yielding loans. We were able to make those significantly below par and so we think that those will not only provide us with some additional yield and liquidity, but also some fairly potential upside as the market has recovered a bit over the last few weeks.

In terms of new deal flow, I think August and September were very slack. I think we started to see more activity in October and November. I think we're still being very cautious, particularly with any cyclical or consumer-oriented credits. We're seeing a lot of those right now and we're seeing obviously a fair amount of competition on both pricing and structure continue, as we have all along, but again, I think we're pretty confident that we'll continue to be able to execute on our new business plan.

Okay. And with respect to the performance of the businesses in the portfolio and to the extent you get kind of monthly P&L statements and EBITDA, are you seeing any material changes in the performance?

Not really, no. We certainly don't see any evidence of the double-dip which was talked about so much during August and September, but we also don't see any dramatic improvement either. We're seeing things sort of struggle to remain flat, maybe up a little bit, but we don't see any dramatic deterioration, but we also don't see any substantial upside, which is not the worse thing in the world for a debt investor to have companies perform nicely, but not blowing out their numbers. They're less likely to get refinanced and therefore, you're likely to hold onto those assets longer.

Okay. And another question -- with respect to the income earned off the CLO fund securities, it -- there's been a general upward trend since 2010, but it's not linear, and I'm wondering, are there seasonal elements to when you get equity payments out of this, or how should we think of that in terms of modeling it?

I think what you are probably seeing is if you recall even back last year, some of the -- it's not linear, because last year, there were a few CLOs that had been --

That's right, [cash trapping], yes.

Yes, cash trapping. So all that has been caught up and so, 2011, for the most part, you're seeing, I guess, somewhat of a more normalized view, although it's -- obviously spreads have gotten better, and so --

Yes, I think -- sorry, Mike -- but I think, John, if you were looking sort of first quarter, second quarter, third quarter, of 2011, you'd probably see a more linear --

(Inaudible), yes.

-- and continuing the upward trend primarily, again, because remember, these funds have locked in very low cost of liabilities and as the assets turn over, generally, what's getting paid off are lower yielding assets with no floors and being replaced by higher yielding assets and sometimes higher quality assets with floors. So I think that's primarily what you're seeing.

Yes.

And is there -- given the rate of repayments, given the reinvestment period, what you're seeing in the marketplace, I mean, is it fair to think this levels off or do you see more opportunity to enhance the yield there?

I don't see it dramatically increasing from here. I think it's going to -- I think you'll start to see it level off.

Well, we were thinking that last quarter.

We were thinking that last quarter. As we started to see payments come in this quarter, it's continued its upward trend.

Okay. And final question -- understanding this development with KDA is absolutely non-impacting with respect to your earnings or cash flows, but I wonder, given the kind of workload to work with the SEC and the auditors to drive, I guess, a response, how long do you think that'll take before you have clarity on the matter?

We're still working with the auditors to figure out what the engagement letter is going to look like and the process, there are some unique differences because KDA or KCAP do not normally need to do any accounting work for the CLOs. Now, we are forced to do that, so we are creating the books and records of the CLOs, some of which information we'll be able to get from the Trustee, because all the cash flows effectively go through the Trustee.

All KDA really does is just manage what the investments in and out are of the CLOs. So there are some unique challenges, but we don't know exactly what the timetable will be. I think on our end, hopefully, we'll be able to create the records of the CLOs fairly quickly. I just don't know how long it'll take to actually do the audit work for that and then to get that out and report it and distributed.

I think the good news here is that this is happening during a period when there's not a lot of audit work going on, and so therefore, it would -- it's a lot -- it's going to be quicker than if this had happened next quarter in the middle of our audit.

Yes.

Great, thanks very much, guys.

You bet.

Thank you. (Operator Instructions) Our next question comes from Greg Mason with Stifel Nicolaus. You may begin.

Great. To follow up on that last bit of commentary there about all the audit work, and it seems like you're putting a lot of time and effort into this, are we going to see any kind of one-time expenses or professional fees associated with that, or will that get charged down at the KDA level?

It will be charged down at the KDA level because it is something that is part of KDA's financial statements. The impact to KCAP, there may be a one-time reduced distribution potentially from KDA up to the KCAP level and then obviously, there will be some more leveled ongoing expense to do the audit work.

It's interesting that FASB last week came out with a, I guess, not an amendment, but a discussion with regard -- and open for comment -- with regard to how these VIEs are treated and really looking at whether or not a VIE should be focused or looked at as an agent or principal relationship.

And obviously, if it's a principal relationship, that's one thing. We would hope that when this is finalized, and if it does get passed and adopted, that KDA may be looked upon as an agent, and we hopefully will not have to go through this exercise at some point maybe some time next year, but we're still evaluating what that means. And we still have to wait for the commentary to be over and see if it does actually get adopted.

Okay. And then how much capital is down at KDA right now available to you at some point to be dividended up?

KDA actually have a few million dollars of cash. Some of that's for payables and year-end bonuses because we accrue that at the KDA level, but it only gets paid out once a year. There is a fair amount of cash down there that could be -- well, that could be distributed up. We'll have to do an evaluation as to whether that's distributed up in the form of a dividend or as a return of capital.

Okay. And if it's classified as a return of capital, it would not show up on your income statement? Would that be --

That is correct. It effectively reduced the cost basis on the balance sheet that you see from KDA.

Okay. And is that an elective feature or is there accounting metrics that would determine that?

There are accounting metrics, but it's a combination of both. There are accounting metrics to see that it is a dividend, but it also is just -- it could be either.

Okay, great. Thanks, guys.

Thank you. I'm showing no further questions at this time. I would now like to turn the call back over for closing remarks.

This is Dayl Pearson again. We'd like to thank you all for your time and with that, we will sign off. Thank you very much.

Thanks, everyone.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day.