BCP Investment Corp (BCIC) 2015 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the KCAP Financial Incorporated's Third Quarter 2015 Earnings Conference Call. An earnings press release was distributed yesterday. If you did not receive a copy, the release is available on the Company's website at www.kcapfinancial.com in the Investor Relations section. As a reminder, this conference call is being recorded today, Thursday, November 5, 2015. 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 the news events, including earnings releases, please contact Jamie Lillis at 203-428-3223. Today's conference call includes forward-looking statements and projections, and we ask that you refer 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. Good morning, and thank you for joining KCAP Financial for a review of our third quarter 2015 results. Today I will review some of the important highlights and activities from the third quarter, as well as provide 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, who will provide a brief recap of our third quarter operating results and our financial condition at the end of the quarter. We will then open the line for your questions at the end of the call. A presentation outlining a few of the key accomplishments in the quarter can be found on our IR section of our website. To start, let me provide a brief recap of some of the important highlights from the third quarter, which were summarized on slide 3 of the earnings presentation.

In the third quarter of 2015, our NII was $0.18 per share and our taxable distributable income was $0.21 per share. As a reminder, we also report a non-GAAP metric, resources available for distribution, which is a good proxy for cash available to shareholders to support our dividend. Resources available for distribution were $0.23 per share in the third quarter. Our third quarter shareholder distribution was $0.21 per share, consistent with the $0.21 paid in the first and second quarters of the year.

I would now like to discuss the performance of our loan and securities business and Asset Manager Affiliates in more detail.

Turning to slide 4, during the quarter, we invested approximately $44 million, which includes a $23 million loan to Trimaran, which is utilized to provide first loss support for the current CLO warehouse. This was primarily funded by repayments and sales of placeholder assets. These new loans had a yield generally comparable to the assets they replaced.

Our credit quality of the portfolio continues to be strong with only one non-accrual loan representing less than $250,000 at cost. While Millennium recently made its interest payment, we expect the loan to be restructured soon. As credit markets continue to become more aggressive, we maintain our credit standards and we'll continue to focus on less risky middle market senior loans for KCAP Senior Funding.

We continue to strive to produce a healthy balance between our three sources of investment income. While we continue to see moderate deal flow, middle market pricing and structure continues to be very challenging for both senior, but particularly junior capital investments. Perhaps a bigger concern is that the quality of the Company that's being financed appears to be rigorous than in previous quarters.

As always, we continue to maintain our standards and as I already said earlier, we will not sacrifice credit quality in order to meet short-term income goals. KCAP believes that the current asset mix and allocation of second lien secured loans, mezzanine loans, and CLO equity represents the appropriate balance to achieve our proper risk adjusted return.

In terms of the market for new CLO funds, the environment has become more challenging, starting in the late summer. We continue to warehouse for our next CLO fund, but we remain very cautious on asset selection. We continue to be positive regarding our ability to issuing these CLO fund in the future. However, the supply of new loans and AAA spreads, which are essential to raising new funds continues to be challenging.

As of September 30, 2015, our weighted average mark-to-market value to par on our debt securities portfolio decreased to 96 compared with 98 in the second quarter. This is consistent with the sell-off in the credit markets.

As far as the CLO portfolio, our weighted average mark-to-market value to par was 60 as of September 30, a slight decrease from the weighted average mark-to-market par of 62 for the second quarter, again, consistent with the market.

Our 100% ownership of our Asset Manager Affiliates was valued at approximately $64 million, based upon their assets under management perspective -- and positive and perspective cash flows at September 30th. Our investment portfolio at the end of the third quarter totaled approximately $437 million.

Looking at the composition of our investment portfolio, our portfolio quality continues to hold up well with no new assets on non-accrual, although with the Millennium restructuring that could change in the fourth quarter.

At the end of the third quarter, debt securities totaled approximately $296 million and represented about 68% of the investment portfolio. First lien loans now represent 83% of the debt securities portfolio and junior loans 17%. All CLOs managed by KDA and Trimaran continue to be current on equity distributions and management fees.

This income stream from our Asset Manager Affiliates allows them to make periodic distributions to us. In the third quarter there was a distribution of $2.3 million. And additionally, as of September 30, 2015, our Asset Manager Affiliates had approximately $2.7 billion of par assets -- par value assets under management, which is down from $3.2 billion in assets under management at the end of the second quarter.

Two CLOs received notices of redemption in Q3, driving the decrease in AUM and impacting the valuation of our M&A since we did not close any new fund in the quarter. While we are looking at alternatives in terms of potentially raising some debt capital to decrease our overall cost of capital, we have no plans to raise equity at this time either in a rights offering or in any other format.

On our most recent conference call, when we were questioned about the idea of a stock buyback, we mentioned two issues that the Board was concerned about. First, we were concerned about a possible sell-off in the credit markets that could cause our leverage to increase to unacceptable levels. Second, we were concerned about the near-term maturity of our convertible bonds.

Unfortunately, the sell-off in the credit markets did occur, which we did not necessarily anticipate what we're concerned about. We were able to purchase $5 million of our convertible bonds in the open market in the quarter to reduce our debt. In addition, we were able to purchase another $3.85 million since the end of the quarter reducing our maturity from $39 million to a little under $30 million. This has accomplished two things, reducing our leverage and lowering the amount of debt due in the short-term.

And now, I'll ask Ted Gilpin to walk through the details of our financials.

Thank you, Dayl. Good morning, everyone. As of September 30, 2015, our net asset value stood at $6.33, which is down 9% sequentially from $6.96 at the end of the second quarter of 2015 and down 8.8% from $6.94 at the end of the fourth quarter of 2014. Quarter-over-quarter change is due primarily to a sell-off and the credit markets in September and to the run-off of two CLOs and the associated fees in our Asset Management Affiliates.

Net investment income was $6.5 million or $0.18 per basic share for the third quarter of 2015, up from $5.8 million or $0.16 per basic share in the second quarter of 2015 and up from $5.5 million or $0.16 per basic share for the third quarter of 2014. Taxable distributable income, a metric we believe is meaningful for a reg was $7.8 million or $0.21 per basic share for the third quarter of 2015, up from $6.3 million or $0.17 per basic share in the second quarter of 2015, and compared to $6.8 million or $0.20 per basic share for the third quarter of 2014.

Resources available for distribution, a non-GAAP measure, which is NII plus tax of distributable excess cash on CLO plus cash distributed by our AMAs in excess of the taxable earnings was $8.5 million or $0.23 per basic share during the third quarter versus $7.4 million or $0.20 per basic share in the second quarter of 2015 and $8.5 million or $0.25 per basic share in the same period of 2014.

The Company declared a $0.21 distribution in the third quarter, which is in line with the $0.21 paid in the second quarter of 2015. Year-to-date, the Company has distributed $0.63 of the $0.66 available for distribution. Interest income on our debt securities for the three months ended September 30, 2015, was $6.3 million or $0.17 per basic share compared with $5.9 million or $0.16 per share for the quarter ended June 30, 2015, compared to $5.4 million and $0.16 per share for the third quarter of 2014.

Investment income from CLO fund securities was $3.9 million or $0.10 per share in the third quarter of 2015, which is down from $4 million or $0.11 per share in the second quarter of 2015, and up from $3.6 million or $0.11 per share in the third quarter of 2014.

We recognized $1.5 million of dividend income from our Asset Manager Affiliates during the third quarter or $0.04 per share, which is up in the second quarter, as recognized dividend of $1.2 million or $0.03 a share and compares to $1.4 million or $0.04 per share in the third quarter of 2014.

The dividend portion of the distributions from our Asset Managers is estimated on an interim basis using a projection of annual taxable income from the AMAs, the tax attributes of the distribution is determined on a full calendar year basis and is finalized at year-end.

These three revenues components contributed to the bulk of our total investment revenue of approximately $11.8 million for the third quarter of 2015, up from the second quarter of $11.2 million. For more detail on the breakdown of KCAP's components, distributable income, please see slide 5 of the third quarter earnings presentation.

The Company recorded net realized and unrealized depreciation of approximately $22.4 million for the third quarter of 2015 as compared to net realized and unrealized appreciation of $2.7 million during the third quarter of 2014.

On the liability side of the balance sheet, during the quarter, the Company purchased $5 million face value of its convertible notes and as of September 30, 2015, our total debt outstanding was approximately $222.4 million. In addition, subsequent to quarter end, the Company purchased approximately $3.8 million of its convertible notes and as a result, our debt outstanding currently consists of $29.9 million of convertible notes due in March 2016 at a fixed rate 8.75%, $41.4 million of senior notes due in 2019 at a fixed rate of 7.375% and $147.4 million of debt, of a debt securitization financing transaction, which has a stated interest rate that resets on a quarterly basis based upon the current level of benchmark three months LIBOR.

Our asset coverage ratio at quarter-end was 205%, which is above the minimum required 200% for BDCs. For additional information regarding the above metrics and our third quarter results, please refer to our 10-Q, which was filed yesterday evening and it's available online with the SEC or from our website www.kcapfinancial.com.

We now like to turn it back over to the operator to answer your questions.

(Operator Instructions) Mickey Schleien, Ladenburg.

Dayl, I just wanted to go back to your comments about repurchasing the convertibles at a premium versus repurchasing the stock at a discount because of the near-term maturity as a convertible. Can I paraphrase that to make sure that I understand that you're worried about your ability to refinance the convertibles, so you're withholding some liquidity in the form of BSL in case that happens or why not sell some of the BLS, reduce leverage and buy back stock?

Well, I think again the Board wants to make sure that we don't do something that puts the Company at risk. And I think as we said on the last call, one of the -- if we had no leverage or very little leverage, we would probably be aggressively buying back stock, but when our leverage is relatively high, it went up because of market not necessarily related to the performance of the Company, but given mark-to-market at the end of the quarter.

And I think that we're very concerned that we make sure we maintain that leverage and one way to do that is to reduce debt and we're obviously looking to reduce the highest cost debt first. And so I think we're going to continue to consider stock buybacks in that context, but there are lot of different things going on in terms of the markets and everything else that we don't want to do something that ends up as a surprise.

We do have enough resources to the buyback the converter or to add maturity. We also have different financing alternatives we're looking at that could also result in some of that income from a much lower cost debt financing to lower our cost of capital, so --

So, we weren't worried about refinancing the debt, we're worrying about the 200% coverage test, which, if we had bought back equity and not bought back the debt, we might have violation of (multiple speakers).

And if we buyback equity, also that gives us last resources to deal with maturity of the debt.

I understand there is a lot of moving pieces, but you do have a lot of BSL, which is liquid and --

No, we don't have a lot of BSLs, it's other than stuffs that's pledged our securitization and that's very low cost of debt financing. So we don't really have -- if you look closely at the Q, we identify what's pledged to the securitization in almost all of the broadly syndicated loans that we do have are pledged to the syndication, to the securitization. So if we sell those, we don't really accomplish anything other than the fact that we create some negative arbitrage on the securitization.

Because the securitization doesn't allow you to redeem any of that debt at this time?

Not at the moment.

Okay, that's the key then. So, segueing into what's going on today, can you give us any color on how CLO equity prices are today, beginning in November versus September? I know liquidity in that market was very weak in the second and third quarters and we've seen pretty severe declines in those prices, but how are they behaving in October, let's say?

Well, I think what -- there hasn't been a huge change, but I will say that the loan markets south has come back up a bit, not all the way, but -- and I had this discussion with another part of our colleagues in another BDC, where September 30th was probably the worst day. There was a price to portfolio, but it has improved a bit and that should iterate through the CLO equity pricing over time, but I think the market still continues to be somewhat stressed, because there is just not a lot of new issue activity. And so, therefore, there is not that much money going into new issue CLOs today, the much was two or three months ago.

What's your sense in terms of bids out there for CLO equity in relation to concerns about the Fed raising interest rates?

I don't really think that they're looking at that, they're looking at the loan market more than anything else. And I think they are credit concerns that people have, not just related to oil and gas, but related to the broader market. And so, I think people are being very cautious. I think the other issue you have is that the big banks are really not holding much on their balance sheets anymore, because they're concerned about their regulators, so.

Right, the risk retention.

The impact of liquidity as well.

Right. I just have a couple more questions. One housekeeping, which investment generated the realized loss or investments?

Yes. When the CLOs were called, whatever was sitting in the unrealized moves to realized. So --

It's just going from one bucket to another.

Okay. So, it was related to the two CLOs that were redeemed?

Yes.

Yes.

Okay. And the markdown on the debt portfolio, was that more technical mark-to-market or was there some deterioration underlying performance apart from Millennium that we should be aware of?

Not -- I mean, most of it was related to the market. We do have one oil and gas loan, which we did take a mark-on, even though which was somewhat market related and somewhat industry related. There was another mezzanine position we have where there is a publicly traded bond, which is consistent with that, which we used to mark our mezzanine position. And they're having to be a very low trade that -- on 9/30 that we used, actually that bond has come back in the meantime. So those were the only two outside of sort of an ordinary sort of attrition because of where loans are as a whole.

My last question is, I was hunting and pecking through the 8-Ks, I couldn't find the answer to whether your shareholders ultimately approved the ability for you to issue stock below NAV?

They did not. I think we could have probably spend a lot of money and gotten that approval, but I think the Board was -- since we were only planning at current prices to raise equity. It wasn't worthy investment in time and effort and so we decided to defer that.

Nick Brown, Zazove Associates.

It's Nick Brown with Zazove. Just a couple of questions. I guess, first, can you shed some more light on that, I think, you said it was a $21 million loan you made to year, how does that matter, just -- I guess, if you are loaning them money to support the CLO's, why are they distributing money to you at the same time?

It's not a loan to support the CLOs, it's a loan to provide first loss for the warehouse and it gets paid back when the CLO is funded. So it's periodically drawn and repaid, it's not a loan to support their operations. It's a loan really to provide first loss capital, which is a short-term loan. It's outstanding anywhere from two months to seven months and it gets repaid.

Okay. So it's not a reflection of --

No. It's purely related to warehouse funding.

Okay. And then just -- the other question, given your comments about wanting to be able to refinance the convert and when it comes due in the next few months, I guess, should we expect in the absence of any new debt financing, should we expect for the next quarter or two for you to continue to sort of shrink the investment portfolio with more repayments and sales and new investments to build liquidity that way.

We're looking at all options. So, I don't know exactly how that's going to play out. I think part of it's going to be a function of timing and part of it's going to be a function of our own leverage.

Troy Ward, KPW.

Dayl, just following up on the last question about the warehouse. So, in an environment where you're aggregating assets for a new CLO and then the market moves away from you, kind of like we saw in the most recent quarter, what's the scenario where we should be worried that first loss position could actually have a first loss.

It's really only two things, Troy. I would be, if the CLO market completely shuts down and you can't do a new CLO, because any new CLO is done, they take the assets at cost. So, as long as you're able to get a CLO done, there is no first loss, which is why sometimes you see people do uneconomic things in the CLO market, like agreed to extremely high AAA pricing, because they are way out over this skies in terms of their ramp. I mean, there are some guys out there who are about $200 million to $300 million ramped right now. We understand they're down, 1%, 2%. Our ramp is very, very small right now and we're being very conservative with that. So, it's a de minimis chance unless the CLO market completely shuts down as happened in 2009.

The other is, obviously if we have a huge big realized loss, you are on the hook for that, because you got to take that out of the portfolio. But again, because there is leverage in the warehouse and there is positive arbitrage, any minor loss you might have on mark-to-market basis generally gets eaten away pretty quickly by the income.

So net-net, when you talk about, the aggregation of the warehouse can be outstanding from two months to seven months. The longer that warehouse is outstanding, the potential or higher risk because the market could move against the assets that you already bought?

Yes and no. It depends upon -- generally the way these warehouses work is during the initial few months, until you actually have equity investors and AAA investors pretty far down the road. The amount of leverage you can put on your first loss is pretty limited, which obviously is something that the banks are concerned of, but obviously it helps mitigating losses.

So what happens is, once you sort of have identified the sort of the two key components to the CLO, which are the AAAs and the equity, then the leverage goes up fairly significantly, because you have to be fairly well ramped when you price the deal and then after pricing is done, the leverage really goes up so that you can be 75% ramped. So, the risk is not all that significant.

Okay. And then switching gears. On table -- in the 10-Q on page 63, there is a table that provides origination and repayment activity and it happens to be in a nine-month period, but obviously, I can just go back to the last 10-Q and kind of back into what that activity was in the September quarter. And what that comes to is roughly $52 million on the origination side. And if we look at the schedule of investments, we can identify roughly $20 million in new portfolio companies and may be that much again in existing, but there still seems to be about $15 million to $20 million air ball with regard to what I can identify at the end of the period. Is there that much trading intra-quarter going on and following upon -- ?

I think what you're missing there is the Trimaran loan, which has zero outstanding at June 30 and had $23 million outstanding at September 30 and probably $23 million outstanding at year-end too.

Okay. Well, that helps, because I couldn't imagine you were doing that much intra-quarter trading?

No. We don't do a lot of intra-quarter trading.

All right. Good. And then --

So, you're right. I think we had about $21 million of originations of new loans in the quarter and then $23 million gets you to $44 million and we had about $42 million, $43 million of repayments and sales.

And then one final one. Looking at the CLOs and specifically the ones that you got the notice of redemption upcoming, you have 13 CLO equity tranches in the quarter at September 30th, 11 of those had a fair value decline of roughly 5%, 5.5%. The two CLOs that you got notice of redemption, they lost half of their value, they went from 52% of original cost of 26% of original cost in the quarter. Explain to me why? I mean, what so changed the fair value of those -- just because you received a notice of redemption? I mean, shouldn't that have been somewhat of an expected event?

Well, that's resulting in the fact that you're in the middle of liquidating assets, so -- and some of that comes back to us in the form of repayments. So, when you're liquidating assets, it brings your basis down because you're getting some repayments and it was a bad market too.

So it was a bad time for the call.

It's a bad time to have a CLO call, to be honest.

In this case, isn't the manager -- who is the manager of the two CLOs that are getting called?

We are.

And what's the income -- well, first of all, the two let's just call, Katonah IX and Katonah X. They both still have an effective interest rate listed in the schedule of investments, did either one of those provide income into the income statement this quarter?

Yes. They both did.

So that goes into your available for distribution, but then we write down the asset by $4 million or something?

Again, the cash came in on and some of that cash is taxable income to the company and again as we're required to distribute that.

But I thought the reason to use the effective yield, I thought we switch to effective yield on these CLO's where you look at the dollar that comes in and you say okay, we're going to assign $0.40 of that to go through the income statement and we're going assign $0.60 of it or vice versa to use to write down the cost basis of the investment. Is that's not what we're doing on the CLO equity?

No, it's exactly what we are doing on the CLO equity.

So, why didn't the cost basis come down?

Again, the way -- we don't assign the 40 and the 60, it's all formulaic. So it's all based on what's original cash flows are, and what it's estimated future cash flows will be and what it's interest rate is calculated to be under that formula, when cash comes in --

But don't you revisit the assumptions? Aren't you the ones that revisit the assumptions?

Every quarter.

I'm at a loss. If you know this is getting called and you know this in a certain environment and you revisit the assumptions, then why are we bringing in anything through the income statement? Why aren't we using that to lower the amount of loss the shareholders are taking? I mean, if you revisit the assumptions every quarter --

We visit them every quarter, where it's essentially on a quarter lag. So if you get, you get caught in a trap essentially of the perfect storm where what happens in the quarter is drastically different than the prediction of the quarter before.

But even if we go back two, three, four quarters, these investments have been below their original cost for an extended period of time. So we knew we were eventually going to have a realized loss, why didn't we change our assumptions to lower that loss? I realize, it's lowering NII in the real time, but it's not a real economic gain, if we take in a dollar, but we know we're going to lose $0.60 of that three quarters from now?

Yes. And again, it's based on their estimated cash flows off those deals. I think we were changing some of the cash flows as we were moving along from quarter-over-quarter and so I'm sure it's been adjusted down over the quarters, but not as drastically as what happened in the third quarter's actual market on those securities.

So most recent quarter of Katonah X had an effective yield of 17.7%, the prior quarter had an effective yield of 16.8%, the effective yield -- no, I'm sorry, it was 43% for Katonah X. No, I'm right, the first time 16.8% the effective yield went up from the June quarter to the September quarter on Katonah X, at the same time the fair value went from $4.6 million to $2.6 million and we took in more income this quarter. I just -- I'm at a loss to understand the accounting. How we call this income when we just lose it at the end of the day?

Yes. I mean, I'd have to go through each deal some time -- there are times when we'd do the exact opposite. But again, the cash flows on the coupon, on those things wasn't changing, what changed was their value on sale, it was really effective there. When we actually got back into fall, it wasn't affecting their cash flow. So the cash flow estimates were fairly [consistent], so.

Just one last one. So, given the way that the accounting works on this, would you expect that book value will continue to decline based on the unwinding of the CLOs?

There's not a lot of unwinding in CLOs left, Troy. I mean, most -- you have essentially --

Eventually there is.

Well, eventually when the new deal, yes, but that was --

Yes. Your book value on all those should come down over time to where you'd expect to be when it gets called, which is what you haven't essentially worked on it, all the other deals rather than K-10 and K-9. We would expect that to work fairly efficiently on the rest of the deals although as we said many times, the effective interest is not nearly as stable and steady as we expect it to be, some times book value will get written up, sometimes it will get written down, but overall, it will be written down to -- essentially, what it should be worth at the call. If you have a dislocation and you actually call the securities -- and at distressed prices, that's not going to happen.

(Operator Instructions) Andy Ellner, JMP Securities.

With the risk retention rule set to take effect in December 2016 and your stock is trading well below book value, prohibiting the issuance of new equity, how are you thinking about the potential for new CLO issuance at your Asset Manager Affiliates, say over the next 18 months?

Yes. I actually think the way risk retention is structured. It's probably going to need less of an investment from KCAP in new funds, because you're going to be buying a strip which is financeable as opposed to equity starting in 2016. And there are also some other ways of dealing with risk retention. So, we think we have capital that we redeployed and continue. Assuming the market is there and assuming it makes economic sense to continue to issue CLOs.

(Operator Instructions) And I'm showing no further questions. I would like to turn the call back over to Dayl Pearson for any further remarks.

I have nothing further. But thank you all and we'll talk to you at the end of when we announce our annual earnings. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect.