BlackRock Capital Investment Corp (BKCC) 2010 Q2 法說會逐字稿

Good afternoon. My name is Tina 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 places on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session.

(Operator Instructions)

Mr. Maher, you may now begin the conference.

Thank you, Tina, and welcome to our second quarter conference call. We will begin by having Frank review 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 this conference call, we may make a number of forward-looking statements. We call to your attention the fact that BlackRock Kelso Capital Corporation's actual results may differ from these statements.

As you know, BlackRock Kelso Capital Corporation has filed with the SEC reports which list some of the factors which may cause BlackRock Kelso Capital Corporation's results to differ materially from these statements. Finally, BlackRock Kelso Capital Corporation assumes no duty to and does not undertake to update any forward-looking statements.

I would now like to turn the call back over to Jim.

Thank you, Frank. Our second quarter performance was strong. Our portfolio continues to produce solid investment income. We remain encouraged by the improving business environment and the positive impact on our investments.

The strengthening economic environment also results in our seeing more and better investment opportunities. We continue to actively manage our existing portfolio. During the second quarter, we sold 8.625 million shares of our common stock at a price of $10.25 per share, receiving net proceeds of approximately $84 million.

We generated more than $180 million in additional cash from repayments and sales of portfolio company's securities, approximately one-third of the value of which were invested in securities that paid interest in kind. We invested $128 million of these proceeds and new investments and an existing portfolio of companies. The net impact was to reduce our leverage. We completed the first phase of our credit agreement amendment, extending a significant portion of our existing debt maturities by three years and we subsequently added new lenders.

For the quarter, we had net investment income of $0.36 a share. Yesterday our Board of Directors declared a regular third quarter dividend of $0.32 a share, payable on October 1st. This dividend is consistent with the Company's second quarter dividend and is supported by our net investment income.

As we look forward to the third quarter, we expect that the deleveraging effect of our recent equity offering, as well as the related increase in the shares outstanding, combined with net repayments and redemptions in the first half of 2010 will result in lower net investment income per share.

Over the long term, we expect to be able to grow our net investment income as we increase our use of leverage for new investments and some of our lower yielding investments are refinanced. Fortunately, our substantial spillover income from 2009 and the first half of 2010 provides the support for our dividend in the near term.

Our balance sheet remains extremely conservatively positioned. Net debt stood at less than $130 million on June 30th. Our statutory BDC asset coverage test stood at less than 0.25 to 1 at quarter end. Our conservative approach to managing our balance sheet has left us in a position of strength with significant capital resources available to put to work in today's improved economic environment.

Net asset value increased again during the quarter and now stands at $642.4 million. This equates to $9.83 per share, up from $9.55 per share at year end and $9.24 per share last June 30th. The volume of new transaction opportunities continues to increase sequentially and improvement in the quality of these investment opportunities has been evident. Solid businesses with improving performances are seeking capital for new transactions and refinancings.

The current investment environment offers us the opportunity to put capital to work at rates that are attractive and accretive to our net investment income. For example, the $90 million investments that we made in fixed-rate debt securities during the quarter have an average cash coupon of approximately 13%.

There are attractive investment opportunities available in the middle market and fewer capital providers to middle market companies. We have an active pipeline of new investment opportunities and we are excited to have the capital resources and the disciplined investment process in place to take advantage of these opportunities.

Mike will now discuss our portfolio activity and market conditions in more detail.

Thank you, Jim. I'm pleased to have the opportunity to speak with you about the portfolio and the current market conditions. Portfolio activity increased in the second quarter and into the third quarter, both for portfolio repayments and exits, as well as for new investment opportunities.

We completed new investments in addition to follow-on investments in existing portfolio companies during the quarter, and restructured two existing portfolio companies as part of change of control transactions.

We are very optimistic about our current deal pipeline and the current origination environment. While we can't make any assurances about whether specific transactions will ultimately close, we do have an active pipeline and hope to close several transactions in the next few months.

Portfolio acquisitions during the second quarter totaled $127.8 million net of fees and discounts. This investment activity is characterized by a diverse mix of securities across the capital structures of seven different companies. The significant majority, where $106.2 million was invested in debt securities, of which $96.7 million was invested in senior notes and senior loans.

We invested $94.7 million in new transactions, including one involving a company in which we had made a prior investment, and $33.1 million in existing securities of other portfolio companies. This includes a new investment to facilitate the restructuring of Electrical Components International in a change of control transactions in which we, together with another lender, took a majority equity position in the business.

Repayments of investments equaled $181.3 million during the quarter. This includes our $59.1 million investment in Advantage Sales and Marketing PIK notes, and with that we have successfully reduced the amount of PIK interest in the portfolio over the last several quarters in an effort to have out PIK income continue to approximate the amount of our dividend reinvestment on a quarterly basis.

The current investment environment is attractive. While the market has been more active recently, new transactions are conservatively capitalized, have lower levels of leverage and higher levels of debt coverage. Middle market lenders like BlackRock Kelso Capital continue to structure better protections and higher credit spreads into transactions.

We continue to believe that the middle market offers the most attractive credit investment profile. Middle market remains characterized by relatively lower leverage multiples of cash flow and debt investments in the current lending environment are markedly more conservative than transactions structured under the market conditions of the previous few years. Middle market debt investments continue to have better loan-to-value coverage than is available in the more liquid credit markets.

The current transaction environment continues to yield improved all-in return opportunities for us. Our portfolio continues to be well positioned. At quarter end our portfolio consisted of investments in 51 companies and was invested 68% in senior secured loans and senior notes, 17% in unsecured or subordinated debt securities, 12% in equity investments, and 3% in cash and cash equivalents.

This increase in equity as a percentage of the portfolio is due to our new equity investment in the restructuring of Electrical Components International, as well as the effect of a smaller total portfolio during the second quarter.

In the second quarter our weighted average yield on income producing securities was 10.5% on a cost basis and 12.4% at market value. Portfolio valuations continued to improve during the second quarter. During the quarter ended June 30, 2010, our net assets increased $22.3 million from operations and our net unrealized depreciation decreased by $23.6 million, reflecting a marked to market increase for the portfolio.

We attribute this improvement to stronger general economic conditions and improvements in the balance sheets and operations of many of the portfolio companies. The effects of cost reduction programs put in place at many of our portfolio companies continue to yield increases in portfolio company profitability and valuations. At June 30, 2010, our portfolio was valued at 85% of cost, an increase from 80.3% of cost at year end 2009 and from a year-ago value of 72.9% of cost.

We're pleased that the performance of our portfolio companies continues to improve. At June 30, 2010, 1.2% of our total debt investments at fair market value were on non-accrual status. The fair value of these assets is $7.8 million at June 30th, compared with $27.9 million at December 31st.

The cost basis of our debt investments on non-accrual was $20 million, or 2.6% of amortized cost at quarter end. This slight decrease in non-accruals is the net result of one new security having been placed on non-accrual and two securities removed from non-accrual and a net smaller total portfolio.

During the second quarter, our investment in American Safety Razor was placed on non-accrual status. For the second quarter our net investment income per share was $0.36. We also reported adjusted net investment income of $0.28 per share. Adjusted net investment income is a non-GAAP financial measure that we use to approximate net investment income as if incentive fees were reflected throughout the year as the related income is earned.

Our as-adjusted results reflect incentive fees based on the formula we utilize for each trailing four fiscal quarter period with the formula applied to the current quarter's earnings and without any reduction for incentive fees paid during the prior three quarters. The resulting amount represents an upper limit of each quarter's incremental incentive fees that may become -- that we may become obligated to pay at the end of the year.

These estimates represent upper limits because in any calendar year, subsequent quarters' investment performance could reduce the incentive fees payable with respect to prior quarter operating results. At quarter end the Company was in compliance with regulatory coverage requirements with a regulatory asset coverage ratio of 520% and was in compliance with all financial covenants under its credit facility.

At quarter end we had net borrowings of approximately $124 million and at the end of the quarter and subject to leverage restrictions, we had more than $495 million of cash equivalents and borrowing availability under our senior credit facility, more than $250 million of which availability extends to December of 2013 under the terms of our amended credit facility.

With respect to our credit facility, we amended it to extend existing lenders commitments totaling $300 million through December 6, 2013. In addition, we added several new lenders to the facility, bringing total commitments that extend through December 2013 to $375 million.

Remaining commitments of $245 million mature on December 6, 2010 unless they are extended prior to that date. Pricing for borrowings made by extending lenders and new lenders is at LIBOR plus either 3% or 3.25% for revolving loans, based on a pricing grid, and LIBOR plus 3% for term loans. Pricing for outstanding borrowings made by non-extending lenders remains at LIBOR plus 7/8ths for revolving loans and LIBOR plus 1.5% for term loans.

Credit facility includes an accordion feature that allows us under certain circumstances to increase the size of the facility by up to an additional $275 million of revolving loan commitments and $250 million of term loan commitments. We continue to approach new lenders to solicit additional commitments to our credit facility.

Since 2006 we've exited 52 investments, of those -- we have exited 49 of those for proceeds that exceeded the fair market value in our most recent financial statements. We took the opportunity to realize some losses in the second quarter, a portion of which may offset income and reduce the amount of any excise tax payable for 2010. Realized losses of approximately $20.4 million were matched by a like amount of net unrealized depreciation reversals.

With that, I would now like to turn the call over to Frank Gordon to review some of the GAAP financial information for the quarter.

Thanks, Mike, and hello, everyone. I will now take a few moments to review some of the details of our second quarter 2010 financial information. Net investment income totaled $20.4 million and $40.7 million, or $0.36 per share and $0.71 per share for the three and six months ended June 30, 2010. This compares with net investment income of $25.5 million and $49.3 million, or $0.46 per share and $0.89 per share for the three and six months ended June 30, 2009.

The decrease in net investment income primarily reflects a reduction in the size of our portfolio due to investment sales, repayments, and restructurings, as well as the impact of lower levels of LIBOR on our floating rate debt investments. Total expenses for the three and six months ended June 30, 2010 were $7.8 million and $15.3 million, versus $7.9 million and $16 million for the three and six months ended June 30, 2009. The decrease in expenses is largely due to lower interest expense and base management fees in 2010.

Total net realized gain or loss for the three months ended June 30, 2010 was a loss of $21.7 million, versus a loss of $10.7 million for the corresponding 2009 period. The net realized loss on investments for the most recent quarter resulted primarily from the restructuring of our investments in Electrical Components International.

For the three months ended June 30, 2010, the net change in unrealized appreciation or depreciation on the Company's investments and foreign currency translation was a decrease in unrealized appreciation of $23.6 million, versus a decrease of $9 million for the three months ended June 30, 2009. The decrease in unrealized appreciation on investments for the three months ended June 30, 2010 includes $16.2 million relating to reversals of prior period net unrealized appreciation as a result of investment restructurings and dispositions.

Net unrealized appreciation was $131.7 million at June 30, 2010, an improvement of $23.6 million from the March 31, 2010 level of $155.3 million. The valuations of our investments were favorably impacted by increases in multiples used to estimate the fair value of some of our investments. Market-wide movements of trading multiples are not necessarily indicative of any fundamental change in the condition or prospects of our portfolio companies.

The weighted average yields of the debt and income producing equity securities in our portfolio, our senior secured loans, and other debt securities at fair value were respectively 12.4%, 11.2%, and 15.1% and at their current cost basis were 10.5%, 10%, and 11.3% at June 30, 2010.

With that, I would like to turn the call back to Jim.

Thank you, Frank. As we look forward from our second quarter results to the balance of 2010, we find that the business environment continues to improve and our portfolio is performing well.

We believe that BlackRock Kelso Capital is well positioned to prudently accelerate the growth of our portfolio. We have increased our equity capital, expanded our base of shareholders, and increased the float in our stock. We've extended our bank credit facilities to December of 2013.

Investment opportunities continue to increase. We expect the environment to support our focus on originating and structuring new transactions. In short, we are in a position of strength to produce profitable growth for the remainder of 2010 and beyond. On behalf of Mike, Frank, and myself, I would like to take this opportunity to thank our talented investment staff for all of their efforts and to thank you for your continued interest in BlackRock Kelso Capital.

Tina, please open the call to questions.

+++ q-and-a

(Operator Instructions)

Our first question will come from the line of Jasper Birch with Macquarie.

Hey, good afternoon, gentlemen. Looking at your funding going forward -- first of all, congratulations on extending the facility. I was wondering when are you -- I mean obviously you don't need a lot more capital available now. I was wondering if you have lenders lined up who want to move into the extended maturity and when you might start doing that, given the higher costs?

Sure. Hey, Jasper, it's Mike. As we have done all along, we continue to speak with lenders who are potential lenders that may join the syndicate over time. We've been very mindful to balance our growth of the facility versus our medium term need because as you know, the new borrowings are at a pricing spread that's more expensive than the old borrowings. And for as long as we keep those old borrowings in place, we borrow at a blended rate that's somewhere between the two absolute rates.

So we do monitor it. We are in conversations. It's not as if -- as soon as lenders actually make firm commitments, it's the type of thing we would disclose to the marketplace were that to happen. And of course as soon as lenders make those types of firm commitments, they would require the higher pay and the higher rate. So again, we balance it and as soon as anything actually happens, we would obviously make statements about that to you all and to the marketplace.

Okay. And in addition to term loans and the revolver, are you looking at any other funding sources that you may be pursuing, let's say the next 12, 18 months?

We always monitor other sort of methodologies of raising debt capital as we look at the liability side of our balance sheet. I would say that we have been in the past and are from time to time in discussions about other sources of capital outside of the traditional bank facility that we have.

It is something that we monitor and it is something that we're always considering. And it's something that going forward as we increase our leverage, it's certainly something that we'll work harder at, think more about and spend more time considering as the total portfolio size grows.

It's always better on our long term goal to have a laddered term loan structure to our debt facilities.

Excellent. Looking at your adjusted results with the incentive fee, I notice that the difference between what your net asset value would be is greater than the actual -- than what the actual incentive fees could potentially be. I was wondering what the discrepancy there is?

Frank?

It's just basically the six months of the as-adjusted incentive fees, so instead of just the $0.08 this quarter, there's also the approximately $0.07, $0.06 in the first quarter.

Okay, that's very helpful. And then, just lastly, could you guys remind us what your current taxable spillover income is?

About $24 million.

About $24 million? Great. Thank you, guys, very much.

Our next question will come from the line of Chris Harris with Wells Fargo Securities.

Thanks. How you doing, guys?

Hey, Chris.

I'd like to talk about credit for a minute here. Some of your competitors put up some kind of weak credit numbers today and I know you guys talked a little bit about this in your prepared remarks.

And you've got new non-accrual loan here and you mentioned that the companies are improving in the portfolio, but just wondering if you'd give us maybe some tangible evidence whether you could let us know that -- whether leverage on average is declining in the portfolio by some amount or is EBITDA actually increasing in your underlying portfolio. I mean anything you could maybe talk to us that would maybe give us comfort that the worst of the write-downs is kind of behind us?

Well, one thing that we actively track, as I think you know, Chris, is we do this -- we have this rating system, sort of a credit watching system. And as we look at the portfolio and we monitor the credits and we rate them each quarter, this quarter's ratings are improved versus the prior quarter.

And that's something that we pretty actively look at because it takes into consideration sort of where the credit performance is, where the prospects for the business is -- businesses are, and also some of the dynamics that are happening as we see things evolving in those credits over time.

So when you look period to period at the change in our overall weighted rating for the portfolio and you see it improving, that's something that monitor pretty closely when we think about credit improvement over time.

I think the other measure is just unrealized depreciation. It continues to -- continues to decrease -- we're valuing the entire portfolio on a quarterly basis and that is reflective of underlying performance of the companies.

Okay. And then on the -- getting back to the leverage topic a little bit, clearly your balance sheet is underlevered at the moment and I know you're planning on growing into that a little bit, but in an ideal world -- and I know this depends on potentially getting additional capacity, but now much leverage do you think is appropriate to put on this business on a go-forward basis?

It's hard to pick an exact number because it depends on at any given point in time what the visibility is and towards repayments or refinancings in the portfolio. We usually have a pretty good idea of what's happening, at least -- at least in the next three months and probably the next six months in terms of repayment.

So at certain points in time, we'll feel more comfortable with more leverage and at other points in time where we don't think anything's coming off -- off of the books, we'll feel more comfortable at lower levels. If I had to pick a number, 0.75, plus or minus, around that.

I think -- Chris, it's Mike. I would just add that while I -- we can only really talk about it on absolute term -- on qualitative terms rather than absolute terms, I would say that one thing that was important as we looked at the portfolio was getting our amount of pay in-kind PIK interest down relative to how we monitor the DRIP program in our shares.

And as PIK interest has come down, it's easier to be more comfortable with leverage because you know that you won't need to ever borrow to fund PIK interest for dividend payments.

Okay. Thank you, guys.

(Operator Instructions)

Our next question will come from the line of Faye Elliott from Bank of America Merrill Lynch.

Hi. Thank you for taking my call. Wanted to ask if we should just expect a growing concentration in investments in -- or new investments, I guess, as opposed to legacy investments going forward? What trends should we look for there?

Well, hey, Faye. I'm not sure it's so much a trend. I think we've -- we have over the last several quarters, as you know, focused our energies on making investments largely in existing portfolio companies. There have been two reasons for that, speaking sort of generically.

One reason is that over the past several quarters -- it's getting to be a year or two, there have been opportunities to purchase securities in existing structures that we were in where there was some kind of distressed seller or forced seller of those securities where there was nothing bad about the business or the actual debt security, but somebody had to sell it for their own reasons, so we were -- pretty attractive opportunities that we took advantage of in that regard.

The second is that, as you know, we structured and recapitalized with the participation of many of the owners, equity sponsors, and other participants in the capital structures, of some of the portfolio companies early on the economic sort of downturn, to insulate them from any -- or whatever negative effects of the economic slowdown we could. And so there was a lot of investment in portfolio companies early on in that regard.

So again, looking back several quarters, more focus on portfolio companies. The other reason that there were fewer new investments during that time is that nobody was really undertaking to do new transactions with the uncertainty in the economic environment.

I think what we've seen this year is that the economic environment has become somewhat more stable, enough sort of repair has gone on in the general sort of corporate lending arena that people are willing to undertake transactions that we're seeing more new opportunities today than we had in some time. And those new opportunities are of a better quality.

So while you can't tell the future, it certainly would seem that should these trends continue, we'd have more opportunities to put money to work in new businesses going forward as we did in the second quarter.

So that's what I was getting at. Do you think that we could start to see some new, fresh names on your list of companies over the near term?

Yes. The answer is yes, and yes.

We're hopeful that that will be the case.

Okay, great. And then would you continue to favor really lower yielding cash pay over, say, a higher yielding PIK investment in order to bring your cash flows more in line with your dividend commitment? Should we expect that as well?

Yes, I think what Mike said was we are mindful of our dividend reinvestment vis-a-vis -- a dividend reinvestment rate vis-a-vis our amount of PIK and we take that into consideration. So I -- and we've actively managed the level of PIK down to a level that we now feel quite comfortable with.

You're comfortable with the PIK level now, or you're comfortable with the way it's trending?

We are comfortable with where it is now and we're comfortable with the way it is trending? We're comfortable with both.

Yes.

We've had -- we've had, in the last two quarters, oh, over $110 million of PIK securities sold from our portfolio, so pretty substantial amount.

Right, and my question really is along those lines.

Are we going to replace -- are we going to replace those with $110 million of PIK? No.

No, but would you continue to replace other PIK on your balance sheet as the opportunities arise?

Well, I think -- I mean, maybe said a little bit differently, we certainly aren't afraid of PIK investments. PIK, pay in kind interest as a small portion of an overall portfolio, where you can earn outsize returns on a compounded basis are something that is attractive to us as a general rule. We're very, very mindful to never let that be a too-significant a portion of the overall portfolio.

So as we've said in different ways today and earlier, we're comfortable with the amount of PIK that's in the portfolio today. Certainly as the portfolio grows we would be comfortable with a similar percentage of PIK in new investments. We wouldn't look to, dollar for dollar, replace old PIK with new PIK. What we look at are the opportunities that are in front us and whether or not those opportunities are structured in a sound way where we can make positive, good risk-adjusted returns, mostly in cash.

Okay, great. Thank you.

Sure.

Our next question will come from Greg Mason with Stifel Nicolaus.

Good afternoon, gentlemen. On the $181 million of repayments, did you have call protections on those and did that flow through this quarter in higher prepayment fees? First question, and then second question, how do you, as you look at your pipeline going forward, what do you think about repayments in the second half of the year? Will that trend down or could that trend up with the M&A environment?

I think -- it's Mike. I'll take the first part, at least. And the simple answer is some. Some of the securities that were repaid comprised the $180 million had prepayment penalties or other penalties for exiting the transaction, others did not. So there's a mix in there, but certainly there are fees that we received in the second quarter that relate to these exits overall.

In terms of trends on repayments, I think, and I truly comfortable with this, knowing where our portfolio sits, that it will clearly trend down in the second half of the year.

Okay, great. And are you able to quantify the prepayment fees that occurred in the quarter? Or, perhaps we can do that offline.

Well, we -- I think generally we don't disclose those as a separate item, so we can't do that on the call, either. Sorry.

Okay. And then one final question on the two loans that went off -- or were removed from your non-accrual bucket, did those come back on accrual status, or were they part of the realized losses in the quarter?

The answer to that -- well, go ahead, Frank. I'm sorry.

Sure. One of them came back on accrual status, also through a restructuring, and one of them was the one we mentioned, Electrical Components International.

Okay, great. Thank you, guys.

And we have no further questions at this time. Are there any closing remarks?

I just want to thank everybody for their attention. Have a good remainder of the summer, and if you have further questions, feel free to give us a call.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may all disconnect.