BCP Investment Corp (BCIC) 2017 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the KCAP Financial Inc. Conference Call. An earnings press release was distributed yesterday. If you did not receive a copy, the release is available at the company's website at www.kcapfinancial.com in the Investor Relations section.

As a reminder, this conference call is being recorded today, Thursday, March 8, 2018. This call is also being hosted on live webcast, which can be accessed at the company's website at www.kcapfinancial.com in the Investor Relations section under Events.

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 CSC (sic) [SEC] for important factors that would cause actual results to differ materially from these projects (sic) [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 for KCAP Financial. Mr. Pearson, you may begin.

Thank you. Good morning, and thank all of you for joining KCAP Financial for a review of our full year 2017 results. Today, I will review our key highlights from the year and strategy going forward as well as provide context for our direct lending business and the performance of our Asset Manager Affiliates. I will then turn over the call to our Chief Financial Officer, Ted Gilpin, who'll provide a more thorough review of our full year operating and financial results and then open the line for your questions.

We accomplished a great deal in 2017 to lower overall borrowing costs, optimize our balance sheet and put ourselves in a position to grow in 2018 and beyond. We are currently evaluating a number of potential transactions to deploy our capital. And we're excited about the opportunities we see in the market.

2017 was a year of transition for KCAP and that had a short-term impact on our earnings but was essential to position us for future growth. Like the third quarter, the fourth quarter also included a number of changes to the balance sheet related to our strategy shift that make it difficult to compare asset composition quarter-over-quarter.

Two high-level points I would like to call out on the composition of our balance sheet are the significant reduction in leverage year-on-year, and the dry powder we are currently -- we currently have available for new investments.

If you look to our overall leverage, you will see that during 2017, our overall debt outstanding decreased by approximately $74 million, and our asset coverage ratio now stands at 271% versus 205% at the end of 2016. So we've taken the balance sheet from the position of being very near maximum leverage to a place where we have a greater degree of flexibility in transactions that we take on in the way we structure those transactions.

We recently entered into a $50 million revolving credit agreement with a syndicate of banks to provide even additional dry powder. The dry powder at year-end, I mentioned, was in the form of approximately $77 million in short-term investments and money market funds and T bills that were readily access as of year-end. These funds made up about a quarter of our overall investment portfolio as compared to 28% at the end of 2016.

Today, we have approximately $30 million of cash for deployment plus $50 million in unfunded revolving credit facility for $80 million of total liquidity for new investments. We have a number of new investment opportunities identified in the short term in excess of $25 million in the aggregate. As we discussed on our last quarterly earnings call, one of the key transactions and repositioning KCAP for growth was a joint venture we entered into with Freedom 3 and the redemption of $147 million in debt.

As you know, part of the transaction was to set up a new fund owned by the JV, which is managed by a wholly-owned Asset Manager Affiliate of KCAP. The fund is now almost fully invested and approximately $300 million are primarily senior middle-market loans. To give you a better sense of the benefits we are seeing, during the fourth quarter of 2017, management fees were approximately $305,000 from this fund, an investment income on the JV was approximately $264 million. Please bear in mind that the portfolio of loans was not fully ramped during the quarter. And as a result, this does not represent an actual full quarter of managing $300 million of assets.

We also have been very active in resetting certain of our CLO funds during the quarter. Specifically, our Asset Manager Affiliates extended the term and increased the size of 2 managed CLOs and reduced the cost of capital of 3 managed CLOs. The resulting lower liability costs increased the value of the equity in the CLO funds held at KCAP. And importantly, the upsizing of these CLOs makes available a significant amount of investable funds.

Now let me give you a high-level summary of our 2017 fourth quarter and full year financial results before handing over to Ted.

For the year ended December 31, 2017, our NII was approximately $11 million or $0.30 per share. Our fourth quarter distribution was $0.10 compared to $0.12 paid in the third quarter.

At the end of the quarter, KCAP had approximately $77 million investable cash, which we intend to deploy in transactions, which generates cash flows we need to further fund distribution to shareholders.

Turning to our direct lending business and the performance of our Asset Manager Affiliates. During the quarter, we invested approximately $50 million in new originations with a yield of approximately 8.5%. We also have a robust pipeline of new opportunities for the balance sheet.

Credit quality continues to be strong with no defaults and 2 assets on partial PIK accrual, where we recognize all of the cash interest and a percentage of the PIK interest.

In terms of the market for new CLO funds, the environment is extremely active, and we expect the positive momentum to continue into 2018.

Our Asset Manager Affiliates were busy in Q4 2017, resetting an upside in 2 CLOs and aggressively lowering the debt cost of another CLO. And all 3 CLOs became risk retention compliant.

Although we have a risk retention solution in place, we are hopeful the expected finalization of the repeal of risk retention rules will further boost CLO issuance.

As of December 31, 2017, our weighted average mark-to-market, and our debt securities portfolio was 94 compared to 95 at the end of 2016.

In terms of our CLO portfolio, our weighted average mark-to-market was 48 as of December 31 versus the weighted average mark-to-market of 54 as of December 31, 2016.

We also called, during the quarter, our last 1.0 CLO Katonah 2007-1 and received a partial redemption of that position of $10 million during the quarter.

A 100% ownership of our Asset Manager Affiliates was valued at approximately $38.8 million based upon the assets under management and prospective -- and positive prospective cash flows. The AMAs have approximately $3 billion of assets under management.

Our CLO equity portfolio at the end of the fourth quarter totaled approximately $52 million.

At the end of the fourth quarter, debt securities totaled approximately $118 million and represented 38% of the investment portfolio. First-lien loans now represent about half of the debt securities, junior loans represent about 40%.

All CLOs managed by KDA and Trimaran continue to return on equity distributions and management fees. This income stream for our Asset Manager Affiliate allows them to make periodic distributions to us. During the quarter, there were distributions totaling $12.9 million or $11.3 million of which was from Katonah '17 -- '07-1, which is winding down, as I mentioned earlier.

Additionally, as of December 31, 2007 -- 2017, our Asset Manager Affiliates had approximately $3 billion of our assets under management.

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

Thank you, Dayl. Good morning, everyone. As of December 31, 2017, our net asset value stood at $4.87 million, which is down from $5.24 million at the end of 2016.

Net investment income was $2.7 million or $0.07 per basic share for the fourth quarter of 2017 as compared to $0.07 per basic share in the third quarter of 2017 down from $4.1 million or $0.11 per basic share for the fourth quarter 2016.

Interest income on our debt securities for the quarter ended 2031 (sic) [December 31,] 2017, was $3.3 million or $0.09 per basic share compared with $2.5 million or $0.07 per basic share for the third quarter of '17.

Interest income on our debt securities was $4.7 million or $0.13 per basic share in the fourth quarter of 2016.

Our debt securities portfolio contribution to total investment income for the quarter was 50%, which compares to approximately 39% from the third quarter and $0.58 from the fourth quarter of 2016.

Investment income for CLO funds securities declined slightly to $2.5 million or $0.07 per basic share in the fourth quarter of 2017 versus $2.8 million or $0.08 per basic share reported in the third quarter of 2017 and down from $3.2 million or $0.09 per basic share in the fourth quarter of '16.

We received distributions from Asset Manager Affiliates for approximately $1 million in the fourth quarter of 2017, $750,000 of distribution was in excess of the AMA's estimated tax from earnings and profits, therefore, treated as return of capital. There were no distributions in the AMAs in the fourth quarter of 2016.

For the 3 months ended December 31, 2017, total expenses increased by approximately $190,000 from the third quarter of '17, and as compared to a decrease of approximately $84,000 in the same period in 2016.

The company recorded net realized and unrealized losses on investments of approximately $1.5 million for the 3 months ended December 31, 2017 compared with net realized and unrealized gains of approximately $816,000 for the 3 months ended December 30 -- September 30, 2017.

And net realized -- and unrealized losses of approximately $4 million in the fourth quarter of 2016.

We'd like to now discuss some of the details of our full year results for 2017.

Interest income on our debt securities for the year ended December 31, 2017, was $15.1 million, down from $20.8 million compared as of year-end, December 31, 2016, due primarily to redemption of KCAP senior funding or on-balance sheet securitization.

Our debt securities portfolio contributed to total investment income for the year was 53% compared with 58% in 2016.

Investment income from CLO fund securities is $11.2 million for the full year compared to $13.3 million in 2016.

We received distributions from our Asset Manager Affiliates of $3.2 million during 2017 compared to $2.7 million in 2016. $460,000 of the 2017 distribution was recognized as dividend income, whereas 2016, $1.4 million of the distribution was recognized as dividend income.

Company recorded net realized and unrealized depreciation on investments of approximately $3.5 million or $0.09 per basic share during the year ended December 31, 2017 as compared to net realized and unrealized depreciation of approximately $19.4 million or $0.52 per basic share for the year ended December 13 -- 31, 2016.

On the liability side of the balance sheet, as of December 31, 2017, par value of our debt outstanding was approximately $104 million compared with $181 million of December 31, 2016.

Our asset coverage ratio at the quarter-end was 271%, well above the minimum 200% required for BDCs.

And with that, we'd like to turn the call over to you for any questions. Operator?

(Operator Instructions) And our first question comes from Ryan Lynch with KBW.

First question I had, I noticed that your guys' -- the cost base of your guys' debt portfolio decreased from the third quarter into the fourth quarter, and also, you guys total investment portfolio, excluding cash and money market and treasuries, decreased from the third and fourth quarter. But I was trying to actually find -- could you disclose the individual movements? I didn't actually see what were the originations that you guys made into new investments this quarter as well as the repayments that you guys made.

Sure. It's a little bit confusing because some of the stuff was related to the joint venture transactions. So let me try to walk you through sort of step-by-step. So in terms of the loan portfolio, we had about a $45 million -- as I said, $45 million of net originations. As I said, 8.44% was the average yield as of year-end. Those are almost all floating rate securities. So as of today, that yield is probably another 25 basis points higher than 8.44%. But as of year-end, it was 8.44%. And our cost basis on that was a little under 99. Then, let's talk a little bit about the joint venture. As you remember, when we funded the joint venture in the third quarter, we took a $185 million worth of assets off the balance sheet, went into the joint venture. Our partner put in, I think, another $25 million. So we had about $210 million of capacity, which is all we really had at that point until we upsized -- we were able to upsize the debt, which we did in -- on October 31 to $300 million. So we had some additional assets on the balance sheet during the third quarter that were then sold in the fourth quarter into the joint venture and that totaled about $26 million. And those were sold at market prices at par and a half roughly. And then, as part of the transaction for the joint venture in the fourth quarter, we also were able to redeem about $12 million worth of the equity, which was in the joint venture as of the end of the third quarter. So we were able to upsize and actually have less equity in the joint venture. In addition to that, we also, as I mentioned, had a redemption -- partial redemption of the Katonah '07-1, which was a 20 -- roughly $20 million position at the end of the third quarter. As you see, I think it's roughly a $10 million position at the end of the fourth quarter that was all a pay down of cash. So that was $10 million. We also received another partial redemption in the first quarter of about $5 million, and we expect to have most of that -- all the remaining $5 million or $6 million redeemed before the end of the first quarter. So that's that. There was also -- as part of the upsizing of 14 -- and resetting of '14-1, we had in the interim basis buy more equity to get that transaction done. But we didn't want to have more than 24.9% of the equity. And so we had -- we sold $5 million of that equity in the fourth quarter. So that's a reduction of $5 million. And as part of the reset, which occurred in the fourth quarter, we had a $1.5 million position in single BPs in '14-1 and that got redeemed as part of the resetting of the transaction. Does that make sense?

Yes, I mean, yes. The -- I -- those are, yes, definitely the details of the movement this quarter. So definitely helpful. Moving over to the joint venture. Just had a couple of questions on that. I believe you guys, within the joint venture, issued a CLO in the quarter, like -- or at least tap CLO financing. Can you just walk us through exactly what went on in the joint venture because it also looked like -- and your investment, which in the third quarter was about a $36 million equity investment, the joint venture is now split between about a $25 million equity investment and then roughly $4.5 million debt investment into the JV. So if you can just walk through exactly what was the transaction or, maybe, CLO financing that the JV did this quarter? Also, how did the total AUM that the JV manages change from the third and fourth quarter? And then finally, how will the -- how will you guys be receiving income from the JV? Will it now be primarily received through interest income, or will you guys still be receiving dividend income because I saw dividend income decreased from the fourth quarter versus the third quarter.

I'll start with the back end of that.

Yes, why don't you start with the back end of that.

And Dayl can talk to you about the -- what the JV was doing. So the JV, again, we will receive investment income from the JV as it relates to its investment in -- our equity investment in JV and its investment in its portfolio -- of CLO portfolio. We received dividend income from our Asset Manager Affiliate as it relates to their management of the CLO part of -- of the CLO itself. So that will show up as dividend income from the Asset Manager Affiliates. And then, we'll receive investment income on the joint venture itself. And if you look at Page 48 of our filing, you can see the line for the joint venture, where there was $36.7 million. And then, we -- you can see that the $11.8 million was sort of return to us. As Dayl said, we didn't need as much equity as it had. So that was actually returned to us that we could use for other things. And then, it had a mark-to-market adjustment on it. So that's what happened to the $36 million, is on Page 48. But Dayl can tell you what's going on with the joint venture itself.

Yes. I think as we talked a little bit in August, we were sort of half way through this. But we redeemed KCAP senior funding on a payment date, which was July 21. We could only redeem it on a payment day. So it will be either on July 21 or October 21. And for a number of reasons, we chose to do it on July 21. And we had an interim financing package in place, which allowed us to transfer those assets, take assets from our joint venture partner and have up to about $215 million to $220 million of capacity in the interim. And our target was always to get to $300 million once the final financing was in place. And so we kept all of the equity, which we had in KCAP senior funding, our partner put in essentially their pro rata piece of the equity, which got them roughly to 40% of the equity at that point. Once we finalized the takeout financing, which happened at the end of October, that provided us with a total of $300 million instead of $220 million of capacity. And it allowed us to also reduce our equity position from $36 million to $24 million. We then chose to buy some of the BBs that were offered as part of the financing package because it -- from our perspective, was a very attractive risk-return and a good use of funds. And so we chose to buy roughly $4.8 million of BBs. Our partner also bought some of the BBs. There were some third parties that also bought BBs. And we bought those at a price of a little over $0.90 of par. So we actually have some ability for some capital appreciation there. And we've actually had a lot of inbound inquiries on selling that. But since we happened to like their yield on it, at current time, we're not in any great hurry to do that. But that's what happened. So then -- so now -- so then as of October 31, we went from roughly $225 million of assets under management to $300 million. But we didn't have $300 million of actual assets in there, some of that was cash. And we were a little bit slower than we had hoped in closing transactions. We actually had a lot of transactions in the pipeline for that joint venture. A lot of those got delayed closings until December or into January, which resulted in a lower distribution than we had hoped for originally. But we expect it to be more of a run rate distribution of what we'd expected starting in Q1, certainly Q2.

So when I look at, I guess, F-39 -- Page F-39 of your 10-K basically has the subordinated securities in the JV yielding about 12.1%. Do you expect that yield to go higher in Q1 due to the JV kind of not being fully ramped in the fourth quarter? I guess, what sort of yield now that going into Q1, that you guys have -- already have the debt financing in there, and the assets seemed like they're pretty much set or about the [deal] or funded late in the quarter release. What sort of yield should we expect in your guys $25 million investment going forward?

Well, I think the distribution that we made in the fourth quarter was not near the 12% because of the drag, as we said, in terms of not at being fully funded until the end of -- actually early November and not being fully ramped until late December or early January. So I don't think you'll see the 12% go higher. But I think you can just do the math, the distribution in the fourth quarter was not a 12% -- not a 3% distribution.

Okay. So 12% is going to be roughly the yield -- distribution yield going forward.

Yes, I mean, I think that -- Look -- and then, again, the other point being the management fee in the fourth quarter was not a full amount on $300 million since we only had $300 million starting in November. So you had a month of management fees on $215 million and then 2 months of management fees on $300 million. So the management fee in the fourth quarter is a little bit light as well.

So you should see those 2 things: increased dividends from the AMA, and the investment income on the joint venture should both go up, now that it's ramped.

Okay. And then, one specific company investment question. Grupo HIMA, that was the investment that you guys, I believe, still have on accrual status and marked it like 64% of cost. We -- there are other BDCs in that investment, and I know you guys can't speak to their process -- evaluation process, but they have a -- they have more substantially lower than your cost, and they actually have that on nonaccrual. So just wanted to know how you guys get comfortable with you guys markings, you guys expect that loan to be on nonaccrual status in the first quarter?

Not really going to comment on what we're going to have at the first quarter. But in terms of the mark, I mean, that was our internal mark. It was also validated by our third-party valuation consultant and by our auditors, who all looked at the mark and were aware of the other marks out there. There's a lot of -- there's one "quote" out there that's "There's never been a trade around," which I think has an impact on all of our marks. But we're very confident with the mark. Company has performed reasonably well through the -- through a fairly difficult period of time. But as of today, it's not on a nonaccrual status. And there's a lot of things going on at the company, which we can't really comment on. But I think, obviously, the first lien is paying all of its cash, interest and the second lien is marked where we have it marked and everyone has a -- it's a very fluid situation.

Okay. But it is still paying interest income currently?

On the first lien, yes. And obviously, the second lien is picking.

Okay. And then, just one last one. You guys mentioned $50 million revolving credit facility closed in Q1 of '18. What was the pricing on that facility?

LIBOR plus 325.

(Operator Instructions) And our next question comes from Christopher Nolan with Ladenburg Thalmann.

I'm picking up on Ryan's question on the revolver. Are you able to tap all of that capacity, if you like, given your current asset composition or does it require some sort of change in your asset composition?

Doesn't require a significant change in our asset composition. But we don't have enough assets today to borrow $50 million. A lot of that's for new assets coming onboard. So -- but it is a mixture of -- yes, we have availability for both first lien, second lien and mezzanine assets as part of that facility.

So give me your current assets, how much can you actually tap?

Probably about $25 million today. But again, we have plenty of cash. So we have actually a redemption notice, I think, as you see in subsequent events, to retire $20 million of our remaining $27 million of 7 3/8% baby bonds that are due with -- in October of '19. So we may end up tapping into that a bit as we redeem that debt.

And I didn't see but any plans in terms of what you're going to replace it with, the 7 3/8%?

Well, by large, I think to some extent, some of that gets replaced by the revolving credit, which obviously is significantly lower cost of capital we have. As you know, we did $77 million sale of 6 1/8% baby bonds in the third quarter. So, again, we have the ability to increase the size of that revolving credit as we increase the size of our balance sheet. So...

Okay. So effectively, it's going to be somewhat contingent on your raise in additional equity capital?

No, no. I mean, we have plenty of abilities for more leverage. I mean, -- so we don't need to raise equity capital nor to upsize the credit facility.

I'm not showing any further questions at this time. I would like to turn the call back to Mr. Dayl Pearson for any further remarks.

I thank everybody for taking the time. And I will be speaking to you soon about the first quarter. Thank you.

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