BCP Investment Corp (BCIC) 2013 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the KCAP Financial, Inc., fourth-quarter and full-year 2013 financial results conference call. An earnings press release was distributed yesterday, March 12, 2014. If you did not receive a copy, the release is available on the Company's website at www.kcapfinancial.com in the Investors Relation section. (Operator Instructions) As a reminder, this conference call is being recorded today, Thursday, March 13, 2014.

This call is also being hosted on a live webcast which can be accessed at our Company's website www.kcapfinancial.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.

Today's conference call includes forward-looking statements and projections, and we ask that you referred to KCAP Financial's most recent filings with the SEC for important factors that would cause actual results to differ materially from these projections. KCAP Financial does not undertake to update its forward-looking statements unless required by law.

I would now like to introduce your host for today's conference, Mr. Dayl Pearson, President and Chief Executive Officer of KCAP Financial. Mr. Pearson, you may begin.

Thank you; and thank all of you for joining KCAP Financial for a review of the fourth-quarter 2013. This afternoon I will review some of the important highlights and activities from the fourth-quarter and full-year 2013, providing some context for our direct lending business and the performance of our asset manager affiliates. I will then turn the call over to our Chief Financial Officer, Ted Gilpin, for him to provide a recap of our fourth-quarter operating results and our financial condition at the end of the year. We will then open the line for your questions at the end of the call.

First I am going to provide a brief recap of some important highlights from the fourth quarter. In the fourth quarter, our net investment income or NII was $0.24 per share compared to $0.23 in the third quarter of 2013. For the full year, NII per share was $0.90 which compares to $0.93 in 2012.

Our share count increase by approximately 6.3 million shares during 2013. Our fourth-quarter dividend was $0.25 per share, unchanged from the third quarter.

I will now discuss our direct lending portfolio and the status of our origination activity. First of all, I want to provide some context to our strategy and the development of both our asset management business and our direct lending strategy.

Our focus in 2012 was on closing and integrating the Trimaran acquisition and restarting the growth of our asset management business. Our ability to continue to issue new loan funds speaks to the success of that strategy.

The next step in our growth strategy was expanding our direct lending business and its contribution to our NII, but doing so in a manner that appropriately managed the risk profile of our balance sheet. In order to do that, we expanded our origination staff by adding several experienced professionals beginning at the end of 2012. We knew it would take time for these new hires to ramp up our deal flow, and we began to see results in the latter part of 2013.

At the same time, we grew our balance sheet by using appropriate additional leverage through an balance sheet securitization, KCAP senior funding. This new debt was very cost effective and allowed us to expand our senior lending activities with middle-market companies.

As a result, the additional leverage did not result in a change in our risk profile. As you know this facility closed in June of 2013.

In the fourth quarter, we closed on approximately $17.5 million of directly originated investments with a weighted average yield of almost 10.5%. We funded these loans with some cash on hand and with approximately of -- I'm sorry, $6.5 million of cash on hand and by selling almost $11 million of placeholder assets yielding 4.4%.

So far in the first quarter of 2014, we have closed or are about to close on an additional $20.5 million of directly originated investments yielding on average more than 11.9%. Most of these will close in March, so we will not see the full impact of these investments until the second quarter. We have another $7.5 million of commitments that should close in the second quarter.

Along these lines, we also continue to rotate out of placeholder assets in KCAP senior funding and reinvest it in higher yielding middle-market loans. In the fourth quarter we invested $11 million in new senior middle-market loans at an average yield of 5.9%, and sold approximately $10 million in senior loans with an average yield of 3.09%.

As a result of our direct lending initiatives and our continued rotation out of placeholder assets, our weighted average yield on our debt securities portfolio increased from 6.8% in the third quarter to 7.3% in the fourth. As a result of the new deals closing in the first quarter, we expect that trajectory to continue.

Combined yield on our total asset portfolio was approximately 12.3% at year-end compared to 12% at the end of the third quarter.

The growth of our direct lending business has also made KCAP less dependent on income from both the CLO equity portfolio and dividends from the asset management business. In the first quarter of 2013, our debt securities portfolio contributed 21.75% of total investment income. By the fourth quarter, that had increased to 36.75%. Again, we expect this trajectory to continue.

Deal flow in the middle market continues to be healthy, although pricing has deteriorated in both senior and junior capital investments since the beginning of 2013. As always, we continue to maintain our credit standards and turned down more than 90% of the transactions we reviewed in 2013.

Let us now turn to our asset management business. Our Asset Manager Affiliate, or AMAs, began warehousing for its next CLO fund in September. As with the previous warehouses, KCAP provided a $23 million loan to Trimaran to fund its investment in the warehouse.

Given the uncertainty created by the rollout of the Volcker Rule, the market was choppy in December and January. But our Asset Manager has continued to warehouse assets for our next CLO transaction.

As of December 31, 2013, our weighted average mark-to-market value to par on our debt securities portfolio was 96 compared to 95 for the third quarter of 2013. As for our CLO portfolio, our weighted average mark-to-market value to par was 67 as of December 31, 2013, a slight decrease from the weighted average mark-to-market par of 68 for the third quarter of 2013.

Our 100% ownership of our Asset Manager Affiliates was valued at approximately $76 million based on assets under management and prospective cash flows at December 31, 2013.

Our investment portfolio at the end of the fourth quarter totaled approximately $441 million. Looking at the composition of that investment portfolio, our portfolio quality continues to hold up well, with no new assets on non-accrual.

At the end of the fourth-quarter of 2013, our debt securities totaled approximately $267 million and represented about 61% of the investment portfolio. First-lien loans now represent 63% of debt securities, and junior loans represent 18%. Approximately 8.5% of our debt investments are fixed-rate investments with a weighted average rate of approximately 11.6%.

As of December 13, 2003, (sic) we had four issues on non-accrual status, representing less than 1% of total assets. These all relate to loans that were booked in 2007. The credit profile of our current portfolio, as I said earlier, is very strong.

All CLOs managed by KDA and Trimaran continue to be current on equity distributions and management fees. Four of the management funds are now paying incentive fees to the Asset Manager Affiliate.

This stable income stream from our Asset Manager Affiliate allows them to make periodic distributions to us in the form of a dividend. In the fourth quarter this distribution was $3.1 million.

Additionally as of December 31, 2013, our Asset Manager Affiliates had approximately $3.2 billion of par value assets under management. As also, we also 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 ask Ted Gilpin to walk you through the details of our financials.

Thank you, Dayl, and good afternoon, everyone. I would like to start by covering some of the high-level financial information and then go into a little more detail on specific metrics.

As of December 31, 2013, our net asset value stood at $7.51, down from $7.96 at the end of the third-quarter 2013, and down from $7.85 at December 31, 2012. One driver to this decline in NAV is our December dividend payable, which accounts for a $0.25 share reduction.

As you may call from last year, we have two dividends that are recorded in the fourth quarter -- that being the third- and the fourth-quarter dividends -- which has the effect of reducing the year-end NAV by the December dividend payable. This rectifies itself in the first quarter. The remainder is primarily attributable to a reduction in the fair value of our Asset Manager Affiliates in the quarter of $6.4 million, as the legacy CLO positions continue to delever and since no new CLOs were closed by us in the quarter.

The Company declared a $0.25 distribution in the fourth quarter, which is consistent with the level paid in the third quarter. Net investment income was $7.9 million or $0.24 per share for the fourth-quarter 2013, which compares to $7.6 million or $0.23 per share for the third quarter.

As Dayl mentioned earlier, new originations generated from our direct lending business was the primary driver to the third quarter and fourth-quarter NII increase. Full-year NII in 2013 was $0.90 per share, compared to $0.93 in 2012.

At this point I would like to review the component pieces of the net investment income for the 2013 fourth-quarter. First, interest income on our debt securities portfolio for the three months ended December 31, 2013, was $4.8 million or $0.14 per share, compared to $3.7 million or $0.11 per share for the third quarter of 2013. For the full year we earned $14 million compared to $12.5 million for the full year of 2012.

The third quarter year-over-year increases, as Dayl mentioned, are a result of our repositioning into higher-yielding investments in both our debt securitization assets, KCAP senior funding, and our direct lending assets.

In addition, our debt securities portfolio had average investments of $216.6 million for the 12 months of 2013 versus $131.5 million for the prior year, an increase of about 65%. During 2013 the contribution of our debt securities portfolio to our total investment income grew, and was 37% for the fourth quarter, which compares to 29% contribution in third quarter of 2013, and 22% in the first quarter of 2013.

Second, dividends from the investments in CLO fund securities were $5.05 million in the fourth quarter of 2013 compared to $5.4 million in the third quarter. For the full year, our CLO fund securities earned $21.2 million in 2013 compared with $21.1 million in 2012. Decrease in the quarter can be attributed to run-off of existing funds, whereas the full year has the effect of the runoff offset by new CLO fund security investments.

Lastly, our Asset Manager Affiliates dividended up to KCAP Financial $3.1 million or approximately $0.09 per share in the fourth quarter of 2013, a slight decrease of about $200,000 from the third quarter due to paydowns on existing CLOs. The year-over-year increase from $4.7 million in 2012 to $12.8 million in 2013 can largely be attributed to incentive fees that the Asset Manager Affiliates are receiving on four CLOs and the addition of our two new Catamaran CLOs, one of which was closed at the very end of 2012.

These three revenue components resulted in total investment income of approximately $13 million for the fourth quarter of 2013, as compared to $12.6 million for the third quarter of 2013.

The Company recorded net realized and unrealized depreciation of approximately $6.1 million or $0.18 per share during the quarter ended December 31, 2013, primarily attributable again to our Asset Manager Affiliates, as compared to net realized and unrealized appreciation of approximately $7 million or $0.27 per share in the same period of 2012. As noted in the previous quarter, we have a new CLO in the warehouse phase which, when it closes, will add value to our Asset Manager Affiliates and replace some of the natural runoff.

On the liability side of the balance sheet as of December 31, 2013, our debt outstanding was $193 million, consisting of $49 million of convertible notes, five-year term and a fixed rate of 8.75%; $41.4 million of notes, seven-year term and a fixed rate of 7.375%; and $102 million net of discount of debt securitization notes, a financing transaction, which is a stated interest rate that resets on a quarterly basis based upon the then-current level of the benchmark, three-month LIBOR. Our asset coverage ratio for the quarter end was 226%, above the minimum required 200% for BDCs.

For additional information regarding the above metrics, and for both the fourth-quarter and full-year 2013 results, please refer to our 10-K which was recently filed. It is also available online with the SEC, www.sec.gov, or on our website, www.kcapfinancial.com.

We would now like to turn it over to you for your questions.

(Operator Instructions) Andrew Kerai, National Securities

Yes, good afternoon. Thank you for taking my questions. I appreciate the color on your direct originations and what you're seeing in the pipeline.

So in terms of what closed in Q4 and what you're seeing in the current quarter, is it fair to assume that the composition of that is relatively similar to your overall book? Meaning primarily first-lien senior secured. Or is that weighted higher towards the mezz, or more of a junior secured position?

Well, I split it into two pieces, Andrew. I mean, the first piece is what we call the direct origination business, which is more second-lien and mezz. Then the second piece, which is what goes in the KCAP senior funding, that is first-lien loans. So it's $17.5 million of more junior securities and then $11 million of senior loans.

Great. Thank you. Then in terms of your mix of placeholder loans, do you guys have that, off-hand, in terms of just the mix that you would consider the broadly syndicated lower-yielding placeholder loans as of 12/31?

Yes. We have right now in the securitization, KCAP senior funding, probably about $17 million in that of senior loans that are lower-yielding. In addition to that, outside of that facility we have another $37 million of liquid assets.

Now, not all of those are syndicated loans; some of those are other lower-yielding liquid assets. But probably maybe $15 million to $20 million of that are syndicated loans. So all together maybe I would say roughly $30 million of syndicated loans.

Great, thank you. That's helpful color. Then just turning to your affiliates for a second as well, I know on the last call you had mentioned that you were looking at some other products in addition to CLOs that you might eventually look to manage in there, which would boost your AUM. Have you guys made any progress on that in Q4, or I guess year-to-date in 2014?

We continue to do that. Those generally are very long lead-time products. So we're continuing to work on those and will continue to work on those.

But I wouldn't anticipate that having a short-term impact; that is more of a longer-term strategy for the Asset Manager. These are things that take a long lead time and a lot of legwork, a lot of which we're doing right now.

Great. Thank you so much.

Mickey Schleien, Ladenburg

Yes, good afternoon. In the last quarter's call you mentioned that you thought the next Trimaran CLO may close in the fourth quarter but potentially slip into the first quarter of this year, which looks like it's going to. But is there a possibility it will actually slip into the second quarter at this point?

Can't really comment on that Mickey. Unlike in the fourth quarter, there is an actually ongoing private placement process. As you know CLOs, are done through private placements, and during a private placement period there is very little that we can comment on.

But there is an active process going on. But I don't really want to cause any harm to that process by commenting further.

Okay. Taking that off the table for the moment if you look at the (multiple speaker)

That being said, just to be clear our goal is to close a minimum of two new CLOs during 2014.

Okay. Taking that off the table for the moment and just looking at your other CLO, your existing CLO positions, whether owned by KCAP directly or by the Asset Managers that are beyond their reinvestment period, as those unwind, what's the downside to the valuation of your assets on a go-forward basis?

In terms of the Asset Manager?

No, my understanding is that as you collect cash flow on the CLO positions either that you own or the Asset Managers own, you have to -- you book that to income, but you also reduce the carrying value of those assets. Maybe I'm mistaken.

But if that is the case, as those CLOs that are beyond reinvestment continue to unwind, I am curious what the downside is to your valuation of your assets.

Mickey, you're -- I know what you're -- this is Ted --

First of all, just to be clear, the Asset Managers do not own any CLO securities. They own management contracts only.

But you're talking about the CLO equity positions that KCAP owns. And yes, essentially you're right in the fact that as we receive the cash, the mark comes down by whatever portion of that cash is attributable towards a payback of the principal, for lack of a better word.

But as that approaches its call date, that levels out, and you're left with -- whatever the mark is, is what we expect to get when the deal is called.

Okay. So how close are we to that?

Again, that is the hard part to predict is when it's going to be called. It could be called -- some of them could be called already; some of them obviously that has been stretched out, because they are cash flowing and paying a very decent amount to the equity holder. That is the one who would call them.

So we haven't really given guidance on when they may be called. Suffice it to say I think we look at it, we say there's a possibility that (multiple speakers)

But I do think the takeaway is that those are flattening out at this point.

Yes. I would say we can probably reach pretty close to the flattening out point on them, certainly the ones that have been past the reinvestment period for a while.

Okay. My last question, just I am curious about a couple of allocations. When look at your portfolio and take out the Asset Managers and the CLO positions that you own, you have a significant allocation to beverage, food, and tobacco and also to finance. I'm just curious what is drawing you to those two segments.

Well, I think to a large extent it's driven by the fact that those tend to be less cyclical businesses, I think as far as talking about the food and beverage part of it. So that's one thing.

I think the finance is the fact that that picks up our $23 million loan to Trimaran, which Trimaran then uses for first loss. So that is sort of a closed loop, so I think you have to back out.

But in terms of the food and beverage, and I think you're going to see probably healthcare kick up in the first quarter. I think again those are businesses that tend to have two things we like, and that is general lack of cyclicality -- not complete, but general lack of cyclicality in generally lower CapEx businesses.

Dayl, is that because you are concerned about the trajectory of the economy? In other words, do you think we are headed for a downturn? Or (multiple speakers)

Whether we are or we aren't, I think at some point there is going to be a downturn. And I think we just -- when you're a leveraged lender you want businesses that can weather the downturn better.

Okay. Those are all my questions for today.

(Operator Instructions) Greg Mason, KBW.

Great, good afternoon guys. First on the asset manager, you had some nice performance fees that came in, in 2013. Can you give us any guidance of how those look for 2014? Do any of those start winding down as some of these older funds start winding down?

Yes, I mean -- again, they would; although when some deals get called then you might get a spike in them as they are called. So it depends on the timing of that.

But -- so I don't think we're predicting them winding down so much in 2014. Again, with the caveat that we don't know when the calls will come or not come. I think --

There is at least one CLO that we know is going or in some sort of incentive fee; but that does not get paid until the deal gets called. So we haven't recognized any of that. So there is that as well.

Great. I think the four CLOs that you talked about last year that ultimately got to paying performance fees, you expect those to be relatively stable here in 2014?

Relatively stable, yes.

Okay, great. Then on the new fundings post quarter-end, the $20.5 million, can you talk about how you have funded those new investments?

Has it come from these lower-yielding loans that you talk about? Or have you received repayments on some of the more core middle-market higher-yielding loans in the portfolio?

We had very little in the way of prepayments that we didn't want to have prepaid. So where that came from is essentially roughly $13 million of things that we sold, yielding 5-ish-%. So an uptick of close to 7%.

Then we actually had some preferred stock positions that were not yielding any cash at all that we were able to sell. And so as I say, at the tick up on two-thirds of that of 7% and then the full 11.9% on the rest.

Okay, great. Then my last question is just about net investment income covering the dividend. It hasn't covered it this year, and I think that is one of the reasons why your stock is yielding 12.4%. Can you talk about your thoughts on getting NII to cover the dividend on a go-forward basis?

Yes. I think the directory is in that direction. And I think as always the Board looks over the next four quarters.

So I think that yes, we didn't cover it this quarter, but $0.01 off is not that significant. I think our yield is moving in the right direction; and I think certainly based upon what we have in the pipeline, we should -- absent other acts that we are not aware of -- have a pretty strong first and second quarter.

Great, thank you guys. I appreciate it.

And that wasn't providing guidance but just commenting.

(laughter) Thank you guys.

JT Rogers, Janney Capital.

Thanks. Good afternoon, guys. I was just wondering if you had just generally any update on the risk retention rules for CLOs and how that might impact you as you look forward to 2015.

I think the whole Volcker Rule debacle in terms of its poor rollout and especially the delay of the CLOs, we were expecting to have risk retention rules promulgated by 12/31 of 2013. Obviously that didn't happen, and it's [prevalent] on 3/31/2014, and we don't think it's going to happen between now and the end of the quarter.

That being said, I think we have some ideas on guidelines for what those are going to look like, and we've had lots of discussions both with banks, counsel, and others. We think it will benefit companies like ourselves that have a balance sheet to make the types of investments necessary to grow their asset management business.

So we pretty much don't know exactly what is going to happen, but I think based upon what we've heard and what we've seen happen in Europe, we think companies that have capital will be benefited by the new risk retention rules.

That makes sense. Does it limit at all your ability to grow the assets under management for KDA? Or is this -- do you have plenty capital on balance sheet that you could support whatever piece of the CLO you needed to, on balance sheet?

We've done the analysis in terms of buying vertical strips and other things, and so we think we can do that. That is -- we will be slightly -- bring down our weighted average yield in that. But one could argue also slightly bring down our risk profile of those investments as well.

Okay, great. Then I don't know if you can talk about it, since you are in the midst of closing another CLO. But I was wondering if you could comment on who is generally buying the CLO triple-A paper. Has that changed at all with the bank assessments that were put on last year?

No, I think it is the same buyers.

All right. Then just in terms of the -- and maybe this is another question that you can't answer at this point. But in terms of the return for the equity holders, wondering how the arbitrage makes sense right now. What kind of yield would you expect on CLO equity?

We would expect something in the low to mid teens. So it's probably slightly lower than a year ago, but still healthy returns.

Yes. Okay, thanks a lot.

Greg Mason, KBW.

Great, thank you. Hey, Dale, this is Troy. I just had a quick technical question. On the schedule of investments, I noticed like a name like Aramark, I will just use that as an example; you have four pieces of that investment: a facility, a C piece, and two D pieces. One of them, one of the D pieces is not pledged to the securitization.

Is the reason for that, is it a concentration issue that you can't do it? And could you use that piece as liquidity to fund a direct origination at a higher yield? I am just trying to think about what is available to roll into higher yields.

Yes, and that's -- actually we did use that subsequent to the end of the quarter. So it's a very good point.

No; it wasn't really a concentration issue. It's just we bought it in several pieces, and we put some of it into the facility for diversification purposes. We could have put more, but we wanted to keep some outside for liquidity purposes.

Okay. That's all I was wondering. Thank you.

Thank you. With that I'm not showing any further questions in the queue. I would like to turn the call back over to the speakers for any closing remarks.

We appreciate everyone's time today and we will be speaking to you again soon, after the end of the first quarter. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Have a great day, everyone.