BlackRock Capital Investment Corp (BKCC) 2008 Q3 法說會逐字稿

Good afternoon. My name is Cody and I will be your conference facilitator today. At this time, I would like to welcome everyone to the BlackRock Kelso Capital Corporation Investor Teleconference. Our host for today's call will be Chairman and Chief Executive Officer, James R. Maher, Chief Operating Officer, Michael B. Lazar, and Chief Financial Officer, Frank D. Gordon. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period.

(Operator Instructions)

Thank you. Mr. Maher, you may begin the conference.

Thank you, Cody, and welcome to our third quarter conference call. I'm joined today by Mike Lazar, our Chief Operating Officer, and Frank Gordon, our Chief Financial Officer. We will begin by having Frank talk about some general conference call information.

Thank you, Jim. Before we begin our remarks today, I would like to point out that during the course of our conference call we may make a number of forward-looking statements. We call to your attention the fact that BlackRock Kelso Capital's actual results may differ from these statements.

As you know, BlackRock Kelso Capital has filed with the SEC reports which list some of the factors which may cause BlackRock Kelso Capital's results to differ materially from these statements. Finally, BlackRock Kelso Capital assumes no duty to update any forward-looking statements. I would now like to turn the call back over to Jim.

Thanks, Frank. We're delighted to have the opportunity to speak with you this afternoon. We're pleased with our third quarter results. We continue to deliver on our goals of becoming the premier provider of capital to middle-market companies and providing an attractive return to our stockholders.

Since our inception in July 2005, we've built a strong team of investment professionals and have an extensive outreach program to access middle-market companies. We have a well-diversified investment portfolio of more than $1 billion in assets and at quarter end the weighted-average yield on the debt and income-producing equity securities in our portfolio was 11.9%, up from 11.3% at the end of the second quarter.

While the third quarter was certainly another difficult one for the credit markets and for financial service companies, BlackRock Kelso Capital completed a solid quarter on September 30. We finished the quarter well capitalized with our portfolio performing well. We achieved a high return on portfolio assets in this past quarter due in large part to rate increases on many of our investments.

We were highly selective and cautious during the third quarter, preserving liquidity and availability to take advantage of the dislocations in the credit markets. Although we invested less than $10 million in capital in the quarter, we have invested in excess of $1.7 billion across more than 100 portfolio companies since our initial funding in 2005.

We view the turbulence in the credit markets as an opportunity for BlackRock Kelso Capital to enhance the risk-adjusted returns on our portfolio. As a business development company, as you know, our balance sheet leverage is limited to 1 to 1 and BlackRock Kelso Capital's balance sheet leverage had approximately .8 to 1 on September 30.

Net of our cash balance on our balance sheet, our ratio of balance sheet leverage was .7 to 1. We have substantial capital resources available to fund additional investments. At September 30, 2008, we had approximately $115 million in cash, cash equivalents, and availability under our senior credit facility.

Yesterday, our Board of Directors declared a fourth quarter dividend of $0.43 a share. This dividend will be paid on September 30 and represents an annualized yield of just under 15% on our net asset value and over 17% based on yesterday's close.

Net investment income for the third quarter was $0.47 a share and our net asset value stood at $11.52 per share on September 30, which represents a decrease in net asset value during the quarter of $0.79 per share. Mike and Frank will discuss more of our financial results shortly.

On August 7, 2008, our Board approved a share repurchase plan under which we may repurchase up to 2.5% of our outstanding shares from time to time. Through October 31, 2008, we had purchased approximately 245,000 shares for $2.1 million. These repurchases equated to approximately 18% of those authorized under the plan and were purchased at a price that was accretive to net asset value.

We evaluate share repurchases on much the same basis as we evaluate new investment opportunities. We believe that our shares provide an attractive current return in total return opportunity, particularly at the levels that we witnessed over the last quarter -- or last three months.

We continue to be pleased with the investment opportunities that have resulted from our direct calling effort. We examined approximately 75 investment opportunities during the quarter and well over 1,300 since our initial funding in 2005. Our well-capitalized position and access to additional funding are themselves competitive advantages in today's difficult marketplace.

During the third quarter, the credit markets were generally characterized by increased instability, culminating with the bankruptcy of Lehman Brothers, government rescue of AIG, the sale of Merrill Lynch, and the conversion of Goldman Sachs and Morgan Stanley to bank holding companies.

While transaction volume and activity in middle-market remains significantly lower than it was at this time last year, we continue to see many opportunities today that are of high quality. Many of our best opportunities today are available in the secondary market. The stress sellers are parting with solid investments in performing companies at what we would describe as fire sale prices.

We believe that the changes in the environment for syndicated loans and public high-yield debt, which remain at very depressed levels of activity and valuation, have produced opportunities for higher returns at reduced leverage. This environment continues to provide a great opportunity for BlackRock Kelso Capital.

We believe that being actively involved in the due diligence and structuring of the assets that we acquire provides us with a conservative portfolio. The terms of the loans in which we invest are conservatively structured with adequate covenants, security, and other protections. These structural protections have been an important tool to reduce the risk in our investments as the economy has begun to slow during the past few months.

The industry composition of our portfolio is reflective of our focus on investments and companies that demonstrates high sustainable free cash flow. The largest industry sections represented in our portfolio are business and other services, consumer products, and healthcare. Our portfolio is dominated by investments where we have played an active role either as the sole or lead investor or as a member of a small club of investors.

Investments made in these negotiated lead and club transactions represent approximately 70% of the assets in our portfolio. We pay close attention to the level of involvement and commitment of the financial sponsors with whom we do business. The capital support provided by committed financial sponsors has benefited many of our portfolio companies this year.

We're pleased with our results for the third quarter and the performance of our portfolios investments. We continue to demonstrate our ability to source investment opportunities in middle-market companies in a slowing market for new transactions. We anticipate that we will benefit from the current market dislocation and expect to pursue attractive secondary opportunities. Mike Lazar will now review our portfolio investment activity in more detail. Thanks, Mike.

Thank you, Jim, and thank you for joining our earnings conference call today. For BlackRock Kelso Capital, the third quarter was characterized by a slowing environment for new transactions due to the general slowdown in the deal business as well as the uncertainty of the credit markets generally.

We sourced our fair share of opportunities, but did not close transactions with any new portfolio companies. We were successful in improving our portfolio through a handful of repricing and credit enhancement events in some of our portfolio investments. This includes one new investment in the securities of an existing portfolio company at a significant discount.

Our quarterly shareholder dividend of $0.43 was supported by $0.47 of net investment income as well as an estimated quarterly taxable income of $0.47. Since inception, BlackRock Kelso Capital's distributions to shareholders have been derived almost exclusively from taxable net investment income.

Year-to-date, BlackRock Kelso Capital has generated $1.34 of net investment income. Taxable income from which our dividends are derived exceeded GAAP net investment income by approximately $0.05 through the third quarter. BlackRock Kelso Capital has distributed $1.29 in dividends to shareholders year-to-date through September 30.

We believe that our portfolio is well positioned for the current economic environment. On September 30, our net portfolio consisted of 62 companies and was 57% invested in senior secured loans and 5% invested in senior notes. At the end of the third quarter, only 3% of our portfolio was invested in equity securities. The remainder of our portfolio -- approximately 29% -- was invested in unsecured or subordinated debt securities.

The remaining 6% of assets were comprised of cash and cash equivalents. And again, as a reminder, we do not make and have not made any mortgage or real estate loans and we don't participate or own any CDO or CLO securities.

Like many, we're very focused on the credit crisis and perhaps more importantly, its effects on the economy. We've worked hard to position our portfolio and each investment in it to withstand an economic downturn to the greatest extent possible. Much of this groundwork was laid as the portfolio was constructed. Toward that end, BlackRock Kelso Capital enjoyed the benefit of more than $100 million of junior capital invested by equity sponsors in support of our portfolio companies during the third quarter.

Those investments represent an increase in the capital and junior securities of those companies of more than 15%. Our involvement in the due diligence, structuring, and documentation of the significant majority of the investments in our portfolio has resulted in our having the opportunity to reprice a portion of the portfolio in the recent credit environment.

On a year-to-date basis, we have repriced more than 20% of our portfolio. In addition, we have received amendment and other fees of more than 20% of our portfolio. The average rate increase on those securities has been in excess of 200 basis points and the amendment fees in excess of 100 basis points.

We experienced $60.6 million of portfolio runoff during the third quarter. Consistent with our business model, BlackRock Kelso Capital earned pre-payment fees on three transactions and sold the participation in an investment that we structured with an initial purchase discount to a third party at par.

The sales and repayments recorded in the past quarter also contributed to our shifting the construction of our portfolio toward more fixed-rate assets. Fixed-rate assets comprise 53% of our debt investments and 50% of our total assets at market value, excluding cash, at the end of the quarter.

The fair market values in our GAAP financial statements are derived by dealer quotes for the securities that are quoted and by engaging third party valuation firms to perform valuations on all the non-quoted portfolio investments. These valuations are performed on a company-by-company basis and a securities-by-security basis for every investment every quarter.

Our portfolio was not immune to the effects of the current economic and credit environment. Total portfolio unrealized depreciation during the quarter was approximately $44.4 million. At quarter end, our net asset value per share was $11.52 compared to $12.31 at June 30. The unrealized depreciation on investments does not have an impact on our current ability to pay distributions to stockholders.

More than 40% of the dollar value of our portfolio is valued by dealer quotes. As we hold most of the investments to maturity, we anticipate that for investments in companies with adequate fundamental performance we will not ultimately realize losses in value. Certain of our portfolio companies valued by dealer quotes experienced significant unrealized depreciation as a result of distressed sales by third parties.

Distressed sales can have a disproportionate effect on the value of an illiquid investment. Market-wide increases in interest yields also contribute to unrealized depreciation. Market-wide movements and distressed sales are not necessarily indicative of any fundamental change in the condition or the prospects of our portfolio companies.

The largest portion of the increase in unrealized depreciation for non-quoted or appraised investments relates to two portfolio companies. Once again, one portfolio company, [Thaigem Holdings], as significantly underperformed its plan and its historical results. BlackRock Kelso Capital continues to be actively involved in working out a recovery plan. In the aggregate, the value reflected in our financial statements for this Company is now de minimis.

The other, Wastequip, is a somewhat cyclical business that has also been affected by significant and rapid increases in commodity raw material prices. While results have been weak due to these factors, management has successfully cut costs and streamlined the sales and market function while maintaining its leading market share position, preparing the Company for an eventual economic recovery.

As many of you are aware, our incentive fee structure has a high watermark. As a result of this feature, which we believe is unique in our industry, BlackRock Kelso Capital paid no incentive fees during the quarter or the year-to-date period due to the change in unrealized depreciation.

We're pleased that the performance of our portfolio companies continues to be strong with an overall weighted-average rating of 1.37 using our 1 to 4 credit rating scale. This compares to 1.32 at June 30 and 1.23 at December 31, 2007. Approximately 4% of investments at value is rated 3 or 4 with the other 96 of the percent of the portfolio rated 1 or 2.

As of September 30, 2008, we have investments on non-accrual status representing just over 1.5% of portfolio value. The fair market value of these assets is $16.5 million at September 30 compared with $17.7 million as of June 30.

Currently, our ratio of borrowings to net assets is 0.8 to 1, leaving us with sufficient capacity for new investment opportunities in what is now a very attractive investment environment. We borrow under our revolving credit facility at Libor plus seven eighths and our term loan at Libor plus 1.5%. At September 30, we had borrowings of approximately $491 million or $430 million net of cash and cash equivalents.

Our access to middle-market transactions, our conservative capitalization, and condition of our portfolio remains strong. We remain well positioned to find the best risk-adjusted return in middle-market companies where we're able to play an active role in due diligence and transaction structuring. I'd now like to turn the call over to Frank Gordon to review some of the GAAP financial information for the third quarter.

Thanks, Mike, and hello everyone. I will now take a few moments to review some of the details of our GAAP financial information for the third quarter of 2008. Investment income totaled $37.4 million and $108 million for the three and nine months ended September 30, 2008, respectively, compared to $34.2 million and $92.4 million for the three and nine months ended September 30, 2007.

The increases reflect the growth of our portfolio as a result of the deployment of debt capital under our credit facility and equity capital from our initial public offering in July 2007. Net expenses for the three and nine months ended September 30, 2008 were $11.9 million and $36 million dollars, respectively, versus $11.8 million and $38.7 million for the three and nine months ended September 30, 2007.

Of these totals for the three and nine months ended September 30, 2008, $4.3 million and $13.8 million were interest and other credit facility expenses. Interest and other credit facility expenses totaled $5.3 million and $14.5 million for the corresponding periods in 2007. In addition, performance-based incentive fees totaled -$0.1 million and $9.4 million for the three and nine months ended September 30, 2007. There were no incentive fees for the nine months ended September 30, 2008.

Expenses net of performance-based incentive fees, interest, and other credit facility expenses for the three and nine months ended September 30, 2008 were $7.6 million and $22.1 million, respectively, compared to $6.6 million and $16.9 million for the three and nine months ended September 30, 2007.

Overall, the increase in expenses was driven primarily by an increase in base management fees resulting from the growth of our portfolio and an increase in other general and administrative expenses. Net investment income totaled $25.6 million or $0.47 per share for the three months ended September 30, 2008 and $72.1 million or $1.34 per share for the nine months ended September 30, 2008.

Estimated taxable income exceeded our GAAP net investment income during the three and nine months ended September 30, 2008. For the corresponding periods in 2007, net investment income totaled $22.3 million or $0.44 per share and $53.7 million or $1.23 per share, respectively.

Total net realized gains or losses for the three and nine months ended September 30, 2008 was a gain of $29,000 and a loss of $1.3 million, respectively, compared to gains of $0.3 million and $0.6 million for the three and nine months ended September 30, 2007.

For the three and nine months ended September 30, 2008, the net change in unrealized appreciation or depreciation on our investments and foreign currency translation was depreciation of $44.4 million and $117.2 million, respectively, versus depreciation of $20.2 million and $22.2 million for the three and nine months ended September 30, 2007.

Net unrealized appreciation was $174.7 million at September 30, 2008 and $20.8 million at September 30, 2007. For the three and nine months ended September 30, 2008, the net change in net assets from operations was a net decrease of $18.8 million or $0.34 per share and a net decrease of $46.4 million or $0.87 per share, respectively.

For the corresponding periods in 2007, the net increases in net assets from operations were $2.5 million or $0.05 per share and $32.1 million or $0.74 per share. Yesterday, our Board of Directors approved certain amendments to our dividend reinvestment plan. Please refer to our Form 8-K filed today for additional details. With that, I would like to turn the call back over to Jim.

Thanks, Frank. Looking forward to 2009, we are very excited about our business and about our prospects. Our portfolio is well diversified, conservatively constructed, and performing well. Private equity sponsors, as Mike mentioned, with whom we have partnered, have committed more than $100 million of new capital during the third quarter to support our portfolio companies through this economic downturn and will continue to support their companies. And finally, I would like to thank you all for joining us on the conference call today. Cody, would you please now open up the call to questions?

(Operator instructions). Our first question comes from the line of [Adam Waldo], a private investor.

Yes. Good afternoon, gentlemen. Just a quick question on your funding sources and terms. Has anything changed over the course of the quarter in light of the really almost unprecedented dislocation in both bank funding and capital markets credit terms and conditions and availability?

No. As Mike mentioned, we have a revolver and a term loan and both of those facilities are in place through the end of 2011.

Okay.

I'm sorry, 2010.

2010 is shown in your 10-Q for the second quarter.

2010.

Can you disclose previously or can you just comment on terms and conditions under which the providers of the revolving credit facility can amend its terms or reduce your available credit?

Mike?

Sure. Obviously, the revolving credit facility is dictated by what I would consider a pretty typical revolving credit agreement and it has certain covenants. But it's really governed more than anything else by a borrowing-based formula and we have a significant amount of excess availability under the borrowing base -- have since the inception of the facility and continue to have a very significant amount of excess availability today. That's really only the significant restriction that the credit facility provides for the lenders.

Okay. So from your standpoint, no changes in terms and conditions versus those that prevailed during second quarter and perspectively, you're not getting any indications from the financial institutions involved in providing the revolver to you of changes in those terms. Is that a fair summary?

That is a fair summary.

Okay, thank you.

The next question comes from the line of Jim Ballan with JPMorgan.

Great. Thanks a lot. The language in the press release around the dividend reinvestment plan is a little confusing. Could you explain what's changed related to the DRIP program, if anything?

Frank, do you want to take a shot at that? It's actually a fairly complicated answer. Go ahead, Frank.

Sure. You'll notice that we recently were declared effective until our shelf registration statement and we got some feedback from the SEC that their thought on the dividend reinvestment plan was that dividend reinvestment should not occur at a price less than net asset value.

They are going to -- that's not their final word on the subject. They said they were going to think that over and talk to other people at the agency. But we took that to heart and made the change in the plan so that it doesn't allow for reinvestment below net asset value.

In order to be crystal clear for this dividend we thought we'd have to take this position because we're not sure we're going to get anything definitive from the SEC between now and the time we pay this dividend. I expect longer-term that we'll be able to go back to the format that we had previously. But at the moment, this is the route we had to take.

Got it. Okay, great. Thanks for clearing it up. And there was a good amount of cash on the balance sheet at the end of the quarter. Are you going to maintain more cash on the balance sheet just to make sure you have access to the liquidity? Or was this just a timing thing that happened to be at the end of the quarter?

No, it's really a question of -- I think you got it -- access to liquidity in a very, very difficult environment where for at least a period of time I think we've sort of got that period behind us to a large extent, but you didn't know who was going to be standing the next day.

Right. Okay.

Given the precision of the timing of the end of the quarter, we just judged that it was prudent -- this is Mike -- just judged that it was prudent to draw the capital and have it in-house rather than have to request it should we want to make a new investment.

And we still today have that on our balance sheet and we evaluate that on a pretty regular basis.

Okay, great. And then just one last thing. Obviously, not a lot of capital put to work this quarter. Again, is that somewhat of a timing thing? Should we expect to see you putting capital to work next quarter? Maybe instead of having sort of a negative investment activity, maybe more investing similar to what you have coming back [at you]?

I think it would be fair to expect that we would have investments in the fourth quarter. We certainly had an opportunity to make investments in the third quarter. Markets were moving rather rapidly, both in the secondary and in the primary market, and we chose to take pretty conservative positions in terms of what we were offering to potential borrowers. They, in some cases, chose to go elsewhere. In some cases the deals didn't get done from a timing standpoint and in some cases they got pulled.

Jim, this is Mike. Just to add to what Jim said or maybe not to add, but to amplify. There were a lot of transactions that we found ourselves working on during the third quarter where by quarter end the asset that had come to market, the company that was for sale that gave rise to our financing withdrew itself from the sales process. I would characterize it as part of the lumpiness -- the general lumpiness -- of the business, particularly during this last quarter because of the market conditions.

Okay. Understood. That's very helpful. Thank you, gentlemen.

(Operator Instructions). Our next question is a follow-up question from Adam Waldo, a private investor.

Sorry. I just want to continue a couple of other questions, if I may, on the funding side. Can you just review for us -- I've only been through about half of your recent Qs and Ks, but I can't seem to determine who are the financing sources for your revolver and term loan. Can you comment on specific financial institutions who participate in those?

Sure. On one of our -- I think as an adjunct to one of our prior filings the references actually made to the credit agreement itself. It does exist somewhere on the Edgar System.

Okay.

However, the major lenders under the original credit facility were Citigroup, J.P. Morgan, Wachovia, Merrill Lynch, Bear Stearns, and UBS. Since that time, other lenders have joined the group including Credit Suisse and others, and the original lenders remain lenders today.

Obviously, Bear Stearns' position has been assumed by J.P. Morgan and they provide the funding on what was originally the Bear Stearns piece. And we anticipate that when the pending two transactions involving Wachovia and Merrill Lynch are completed that the funding obligations under our credit agreement will transfer to the ultimate parents of those two institutions -- Bank of America, Wells Fargo.

Okay. Have you had any preliminary conversations with the bank group about extending the duration of the revolver or is it really premature to try to extend duration in the current credit environment given the dislocations in the bank group?

It would be pretty -- this is Mike again. It would be pretty irregular to approach the bank group about an extension two years ahead of the maturity of a facility of this type.

Okay, okay.

Furthermore, this would not be the best time to do it --

Right.

If we were to break with tradition and extend it --

Fair enough.

-- 24 months or 26 months in advance, this wouldn't be the credit environment in which to make that determination.

Right. I didn't want to presume the answer for you. I guess where I'm coming from on this is you're putting out investments with somewhat longer duration than your remaining revolver term. And I guess my concern is do you potentially get a rollover issue there or a duration mismatch or both a year out if the general credit markets environment remains challenging and how would you help us think through how you would manage through that potential situation?

Well, I think again, the agreement remains in effect until the end of 2010. So we do see ourselves as having plenty of runway in that regard. Other BDCs as well as other financial companies have found ready access to capital even in this terrible credit environment. They've just had to pay a pretty healthy premium in pricing to obtain that credit.

And so what you've seen, or what we've seen in the marketplace is people only come to market when they absolutely have to and those that have come to market have required some small premium versus their prior borrowing rate to get a new deal done or a deal extended. And toward that end, we wouldn't look to extend this current two-year maturity in the current credit market environment because --

Yes, fair enough, because you don't want the terms and conditions to change materially until you have to face that.

Correct.

Okay. But let's assume the current environment exists two years out -- and gosh, I think we all hope it doesn't -- but how should we think about your ability to at least maintain that interest margin spreads as you potentially face that rollover issue?

Well --

A couple of things. One, in terms of assets coming on our books. They are coming on our books at substantially higher prices than some of the assets that are higher yields and some of the assets that exist on our portfolio --

Right. Then the capital you're putting out is at higher rates plus you've got a favorable reset.

And during the next couple of years I suspect they'll be some turnover in the portfolio of some significance. So we sort of view it as not a question of difficulty in terms of refinancing and it's really just a question of cost. And I think it may be that the spread gets narrowed.

It may not be at that point in time because it depends a lot on -- I think that the rate that we're borrowing at -- or will be borrowing at -- will be very reflective of the rates that we're lending at. They can't be disconnected by much.

They can't be disconnected by very much for very long. Is that fair?

Right.

Okay.

That's fair.

Thank you, gentlemen.

Gentlemen, there are no further questions at this time.

Terrific. Well, thank you all.

Excuse me, gentlemen. We do have one last question --

Sure.

From [Gerald Batini] from Credit Suisse.

Yes. Hi, good evening. I just want to make sure that I understood correctly. You said that the financial sponsor injected $100 million in your portfolio companies and that represents an additional 15% of equity or in total 15% of equity?

It represented -- In the companies that they injected company --

Yes.

I mean money into -- equity money into -- it represented 15% of what they already had invested in the companies.

Got it. Great. Thank you very much.

Sure.

Thanks again.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect your lines.