BlackRock Capital Investment Corp (BKCC) 2012 Q2 法說會逐字稿

Good afternoon. My name is Ashley and I'll 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; Chief Financial Officer, Corinne Pankovcin; and Secretary of the Company and General Counsel of the Advisor, Laurence D. Paredes.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. Mr. Maher, you may now begin your conference.

Welcome to our second quarter conference call. Before we begin, Larry will review some general conference call information.

Thank you, Jim. Before we begin our remarks today, I would like to point out that certain comments made during the course of this conference call and within corresponding documents contain forward-looking statements subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may and similar expressions.

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.

BlackRock Kelso Capital Corporation assumes no duty to and does not undertake to update any forward-looking statements. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, BlackRock Kelso Capital Corporation makes no representation or warranty with respect to such information.

Please note that we have posted to our website an investor presentation that complements this call. Shortly, Jim and Mike will highlight some of the information contained in the presentation. At this time, we would like to invite participants to access the presentation by going to our website at www.blackrockkelso.com and clicking the August 2012 Investor Presentation link in the Presentations section of the Investor Relations page.

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

Thanks, Larry. Good afternoon and thank you for joining our call today. We're pleased to report that we had another productive quarter and first half at BlackRock Kelso Capital. In the second quarter, we made new investments aggregating $148.2 million. On a net basis, the portfolio grew by nearly $70 million. Total investments, at their current fair market value, were $1.166 billion at June 30, compared to $1.095 billion at the end of the first quarter.

Our leverage stands at 0.64 times at the end of the second quarter. The funds that we used during the quarter to increase our investment portfolio were provided by borrowings under our revolving credit facility. Weighted average yields increased during the second quarter and our portfolio company performance remains strong with only one investment on non-accrual.

We continued to deliver sequential net portfolio growth consistent with our goals and remain pleased with our investment opportunities. The second quarter exhibited an increase in opportunities we tracked relative to the first quarter in the same period a year ago. Our relationships with a broad group of private equity firms, commercial banking firms, investment banks, and management teams continues to provide us with substantial deal flow.

We have sufficient debt capacity to grow our portfolio. Net debt as of June 30 was equal to $438 million, relative to the $1.2 billion fair market value of our assets. At quarter end, we had more than $100 million available under our existing revolving credit facility and $251 million of statutory availability under the BDC leverage rules. Using our available debt capacity, we are able to increase net investment income without raising additional equity capital.

We continue to invest in transactions with appropriate risk-adjusted returns. Market conditions remain somewhat volatile, dominated by macro factors and fragile general economic conditions. We remain focused on dividend coverage. For the quarter, we had net investment income of $0.30 per share and $0.25 per share adjusted for pro forma incentive fees. Our adjusted NII is consistent with our first quarter adjusted results and in line with our expectations.

On August 1, our Board of Directors declared a quarterly dividend of $0.26 per share payable on October 3 to stockholders of record on September 19, 2012. Based upon our portfolio performance and our adjusted net investment income run rate, we remain confident that we will be able to continue to earn our dividend.

So far, the third quarter of 2012 is off to a slow but solid start, consistent with the seasonal transaction slowdown we typically witness in the summer quarter. Although Europe continues to be an issue for the global economy, domestic economic conditions remain relatively stable. We expect that the macro headwinds will continue to persist in the global markets, contributing to continued market volatility.

We remain optimistic for our business as volatile liquid leverage finance markets tend to benefit BlackRock Kelso Capital. Relationship transactions continue to deliver even greater value to our transaction partners now than they do in overheated markets.

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

Thank you, Jim. Good afternoon and thanks for joining our call today. I'm pleased to be able to talk about some of our financial results and to discuss how market conditions affect our portfolio strategy. As previously mentioned, in advance of this conference call we posted our quarterly investor presentation to our website, and the financial section of our presentation starts on page eight.

With respect to the details, total investment income was $35.5 million for the second quarter, up from $33.2 million for the quarter ended March 31. Net investment income totaled $0.30 per share, compared with $0.26 per share in the first quarter of 2012.

Had our incentive fees been accrued ratably throughout the year rather than heavily weighted to the fourth quarter, as required under GAAP, our net investment income would have been $0.25 in the second quarter of 2012, consistent with $0.25 for the first quarter of 2012 as adjusted.

As a reminder, beginning last quarter we separated out the components of our revenue into interest, dividend and fee income on our consolidated statement of operations to help readers compare these income components from period to period. Adjusted to remove the effects of capital structuring fees, consent fee and prepayment fees in each quarter, our investment income for the second quarter was $31.7 million, relative to $29.7 million in the first quarter and $30.5 million in the fourth quarter of 2011.

Fee income in the second quarter equaled $3.8 million and included fees related to new investments, prepayment fees, and other prepayment income and amendment fees. Fees earned in the first quarter of 2012 equaled $3.5 million, excluding all of our fee income. Second quarter pre-incentive fee, net investment income, was equal to $0.25 per share.

Our current portfolio provides us with a stable base of net investment income per share regardless of new investment activity and associated fee income. Fee income also tends to be relatively consistent for our business as we earned fees not only for new transactions, but on amendments, prepayments, and for capital structuring as well.

Total expenses for the second quarter were $13.1 million, versus $14.2 million for the prior quarter. Of these totals for the quarter ended March 31, $2.2 million of incentive management fees were incurred, versus none for the second quarter. Base management fees were $5.5 million for the second quarter, compared to $5.4 million for the prior quarter. On a pro forma basis, incentive management fees for the second quarter were $3.8 million, versus $2.6 million for the prior quarter as adjusted.

In total, we invested $148 million during the second quarter. We made two new portfolio company investments, which totaled $63.5 million of par value. In addition, we made investment in new financings for two existing portfolio companies of approximately $43 million as well as several investments across the existing securities of existing portfolio companies.

Our net portfolio growth exceeded our guidance given at the time of the last investor call, and this was principally a result of one new investment that we originally expected to close during the third quarter, which actually closed on the last day of the second quarter.

Investments in new portfolio companies during the second quarter included $43.5 million in the senior notes of SVP Worldwide and $20 million in the senior secured notes of Advanced Lighting Technologies. Each of these new investments bears a fixed rate of interest and each was issued with a transaction structuring fee payable to BlackRock Kelso Capital. All in, our expected yield from maturities for these securities are 14.6% and 11.5%, respectively.

In addition, during the quarter we made investments in new transactions for Attachmate and for Progress Financial. As a result of these transactions, our commitments increased from $35 million in the prior loans to $54 million in the current loan facilities. BlackRock Kelso Capital earned consent, structuring, commitment, and other fees in conjunction with these new financings.

During the second quarter, we also added $12 million [at] par amount to our investment in the first lien term loan of Penton Media and $5 million to WBS Group's second lien term loan. In addition, we were able to acquire $3.3 million to add to our investment in BPA Labs. Investments in these and other securities of existing portfolio companies were generally a series of opportunistic secondary market purchases at significant discounts to par.

The weighted average yields of the debt and income producing equity securities in our portfolio at their current cost basis were 12.4% at June 30, compared to 11.6% at March 31. During this period, our weighted average yield at fair value was 12.5%.

Non-accruals remain low, currently 0.3% of our total debt portfolio at fair value, which corresponds to 0.8% of our total debt portfolio at cost is held on non-accrual. The weighted average rating of our portfolio of companies at June 30 was 1.17. This is relatively stable with the prior quarter, as portfolio company performance remained strong. In addition, the average rating benefitted from continued portfolio rotation into a higher percentage of recently structured credits and some proactive credit-accretive actions taken at certain portfolio companies.

So far in the third quarter to date, we have experienced portfolio repayments which have totaled approximately $27 million. This includes the repayment of our fixed rate subordinated debt and the sale of our equity interest in Conney Safety Products. We anticipate further repayments in the remainder of the third quarter as we have identified at least one additional asset we expect to prepay prior to September 30.

Principal among likely September quarter repayments is MedQuist, which is also known as M*Modal, which announced on July 2 that its board had accepted a $14.00 per share cash offer that's expected to close prior to September 30.

BlackRock Kelso's $43 million investment in the subordinated debt of the company will be redeemed as part of the transaction, and we expect to benefit from substantial prepayment penalties in conjunction with that redemption. We generally view early repayment of our investments as a positive since we typically receive fees or prepayment penalties in conjunction with these events.

With that, I'd now like to turn the call over to Corinne to review some of the GAAP financial information for the second quarter.

Thanks, Mike, and hello, everyone. I will now take a few moments to review some of the details of our second quarter 2012 financial information.

In comparing the second quarter 2012 with the first quarter 2012, our total investment income increased approximately $2.3 million to $35.5 million, or $0.48 per share. The increase in investment income for the three months ended June 30, 2012 is primarily attributable to higher average rates and fees on an overall larger average portfolio during the quarter.

Fee income earned during the second quarter was $3.8 million. Net investment income totaled $22.4 million. NII per share was $0.30 for the three months ended June 30, 2012 as compared to $0.26 for the three months ended March 31.

The percentage of our portfolio comprised of senior loans and notes has remained somewhat stable at 70% today, compared with 73% at the end of 2011. Of this, 24% of senior notes and loans were secured by a first lien, 55% were secured by a second lien, and 21% were senior unsecured. At quarter end, the balance of our portfolio was 18% invested in unsecured or subordinated debt securities, 11% in equity investments, and 1% in cash and cash equivalents.

At June 30, we were in compliance with regulatory coverage requirements with an asset coverage ratio of 255% and were in compliance with all financial covenants under our debt agreements. We did not purchase shares of our common stock during the three months ended June 30.

During the second quarter, BlackRock Kelso Capital had a net realized and unrealized loss on our portfolio investment of approximately $1.4 million. On a per share basis, net asset value was $9.61 at June 30, 2012, up slightly from $9.59 per share at March 31. The increase and $0.02 per share were primarily due to higher net investment income for the quarter.

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

Thanks, Corinne. We're pleased with our performance so far this year. And as we look into the remainder of 2012, we remain optimistic about our current position. Overall, the pipeline of opportunities remains solid. We expect that the bank and insurance company capital that has historically served this market is likely to be increasingly constrained by more regulation and by stricter capital requirements.

We continue to build on our higher interest income run rate and we expect to continue to increase it through the year. We benefit as the level of consistent and reoccurring interest in dividend income increases as our portfolio grows. We remain focused on continuing prudent portfolio growth while focusing on preservation of capital.

We believe that we have a proven investment process, combined with the market presence that enables us to be successful in our credit selection and structuring, even in tight market environments. As the broader debt market strengthens, we remain disciplined in seeking outsized returns without taking any inappropriate risks.

On behalf of Mike, Corinne, Larry and myself, I'd like to take this opportunity to thank our investment team for all of their efforts and to thank you for your time and attention today. Operator, would you now please open the call for questions?

(Operator Instructions). Our first question comes from [Jonathan Bock].

Can you hear me?

Yes. Hi, Jonathan.

Hey, guys. All right. Thanks. A quick industry question for you, Mike, first. Just with the tightness we've seen in credit spreads today, maybe how you're looking at mezzanine investments and the risk/reward there overall. Maybe a little bit more color there, if you could.

Sure. I think -- spreads have tightened somewhat during sort of toward the tail end of the second quarter and into the third quarter. And the liquid credit markets that -- whose spreads we were tracking when we described that movement, tend to be influenced by, as you guys know, inflows and outflows of mutual funds and institutional accounts that are pursuing liquid, quotable, tradable loans.

On our side of the ledger, we're trying to focus on what we describe at BlackRock Kelso as off-the-run securities, things where we can get involved with proactive due diligence, relationship investing, and where we can structure each investment and sort of take advantage of whatever credit-accretive sort of structuring elements that we can bring forward in the transaction.

So, whether we're talking strictly about subordinated debt or unsecured debt, or even with respect to the senior loans that we're making, we're always entering the capital structure in an actively diligenced and actively negotiated transaction. That's just slightly different than sort of the market that's out there pricing deals on a more liquid and a more [flow-name] basis.

So, overall, tighter spreads over time will affect us slightly, but we tend to be pretty selective on the credit front and get involved in transactions where we can really earn an appropriate risk-adjusted return. Sometimes that return may be lower in a certain environment, but we do things to improve the risk profile of those transactions.

You can see that in the two deals that we did in the quarter for new companies that we weren't involved with before. We have in one case the senior unsecured loan, in the other case a senior secured loan -- both of which have double-digit returns associated with them.

Okay, great. Thanks. Next question, regarding capacity, as I calculated, I think you're about 8% of available credit capacity as of the most recent investment portfolio and leverage at around 0.64. And, Jim, could you speak to really how much higher you'd be willing to take that leverage? Would you be willing to draw all this down, or would you perhaps maybe keep a little bit of dry powder available in the event that markets back up?

Yes, sure. I think we -- I know we continue to sort of examine every opportunity out there. And to the extent that we find opportunities that are attractive, we'll continue to invest the capital. And the answer to your -- the direct answer to your question is that if we use the hundred -- if we find available transactions to use the $100 million that's currently available under our credit agreement, we will use it and feel quite comfortable with that.

At the same time, I would point out that we have a fair amount of visibility into what's coming off of our books, and Mike talked about that a little bit earlier, and we're probably going to see between $70 million and roughly $110 million in repayments in the next quarter. So we think about availability as substantially more than the $100 million that's currently drawn -- currently was drawn -- was drawn at the end of the quarter (inaudible).

That's great color. Then, I guess, with the substantial increase in repayments expected at third quarter, you'd probably not be considering a below NAV equity raise. Is that correct?

I think that would be correct.

All right, guys. Thank you very much.

Yes.

Your next question comes from [Troy Ward].

Great, thank you. Real quick, I may have missed it here, but could you tell me what the weighted average yield on the new investments in the portfolio was this quarter?

We don't separate that out, but at the end of the quarter our weighted average rate on all of our debt and income securities was 12.4%. And if you look back at the prior quarter, you'll see that it was -- and correct me if I'm wrong, Corinne -- 11.6%. And so obviously, on average, between the repayments that happened during the quarter and the new loans that were booked, we were able to increase and rotate into higher overall yields for where we exited the quarter versus where we entered it.

The specifics on the two new transactions for new companies, as opposed to refinancings or opportunistic purchases, came at 14.6% yield to maturity and an 11.5% yield to maturity.

Okay. And when you take the -- when you think about the weighted average yield when you were doing the portfolio, for instance, last quarter, would that have included -- you obviously had a couple of large investments that technically weren't on non-accrual, but I know [your accrue pick] on the fair value, which was very low. So, did the overall yield in the portfolio benefit? Is that part of the pick-up, do you think?

Yes, I think that's part of the pick-up, particularly when you look at it on a cost basis because, as you know, we measure this both on cost and on fair market value. So on cost in particular you'll see some effect in the numbers quarter-to-quarter for the effect of those -- it's really one transaction in particular.

Right. Okay. And then, speaking about the big movements in the portfolio this quarter, I mean last quarter as you try and look at the fair value of the portfolio, we just sit and rank it. Last quarter, you had $122 million in the portfolio at cost marked below $0.80 on the dollar. And if just looking at that number this quarter, it's all the way down to $46 million and obviously I guess I call it a clean-up of the portfolio. You took some sizeable realized losses. Was there a reason that -- what did you see this quarter in the market, I guess, to make you make those moves in the portfolio?

Sure. And let me step back for a second, Troy. I think specifically during the quarter we had -- I'm going to use approximate numbers now -- we had approximately $75 million of increase or appreciation in our net unrealized account, offset by almost exactly the same amount of approximately $75 million of realized losses.

Right.

So on a net basis, there wasn't a significant change as you look at the value of the portfolio period to period; it was just really the realization of some losses that had already been accounted for as written down assets over time.

I understand that --

(inaudible). Sure.

(inaudible) on a cost basis.

Sure. So why do we do that? Why did we realize the losses on it at this moment in time? It's our -- it's management's position and desire and goal to manage the portfolio as effectively on a tax basis as we can. One element of this is that when we are able to, for tax purposes, realize a loss, which, of course, gets picked up in our GAAP financial statements because of the accounting that goes with being a RIC. We will do that, because what it affords us is the opportunity to pass along that tax shield to the extent it can be utilized by -- to our shareholders.

So whenever we are in a position to realize a tax loss, whether or not that means we expect to lose money over time on a deal, we will always take advantage of that opportunity. And that occurred, for example, during the second quarter and it has occurred in other periods in the past. This is something that we don't speak about very often because it's not a GAAP accounting concept as much as it is a tax concept, but we are very cognizant of and manage to the greatest extent possible these tax losses on securities that are typically -- like was the case in this quarter -- already written down for a fair market value basis.

Great.

And the timing of the specific realized losses was based on transactions that were restructured, or about to be restructured, during that period of time.

And, as Jim said, that affords us -- that's what triggers the opportunity to take that tax loss.

Right. And then, one final question. On WBS Holdings, first of all, could you give a little bit of color on what that is, from a software perspective? But then, more importantly, as I looked to scheduled investments last quarter there was an equity piece, a Class B, that had a cost of $16 million and a fair value of $7 million. It looks like it's not in there, but now there's an equity piece with a cost of $1 million and it's written up to $7 million, so there's the $6 million unrealized gain in the books.

Can you just tell us what happened in that investment over the three-month period?

Sure, and I will try to do this at as high a level as possible and, of course, I would be happy to follow-up on more detail offline if you like. But, at a high level, WBS Group Holdings and WBS Group LLC is a holding company for a business called Marketron. Marketron is a software provider, basically for billing and tracking systems, to principally radio stations and other broadcasters.

This is a business we've had an investment in for some time. The company has underperformed our expectations by some amount, but has not -- to say it globally -- has not fallen off a cliff, but just has sort of had prolonged and continued slight underperformance.

What happened in this case was we owned two securities, a second lien loan and preferred equity. Also, in the capital structure that we did not own there existed a first lien loan and common equity. As part of our restructuring transaction as maturities on the first lien loan came due, we did -- we were involved in the restructuring of the capital structure of the business and in a very active way we put more money to work into the business.

And we did that by acquiring from the first lien lenders the existing first lien loan and restructuring it and in conjunction with that we cancelled our existing preferred interests. Cancellation of those preferred interests, by the way, would be in the realized loss category that we're talking about a moment ago. And we recapitalized the common equity of the Company as the principal owner for basically a small contributed amount. I think -- Corinne, correct me -- I think it was $1,000.00.

In the prior period, the value of the preferred equity that we owned was approximately $7 million. And lo and behold, the third-party valuation firm, given the restructuring that occurred, had a very similar point of view, that the new common equity of the Company as there is no more preferred stock in front of it, has the same approximate residual value, or approximately $7 million, that the preferred stock enjoyed in the prior valuation process.

Okay.

Does that make sense?

Yes, I think it does. Net-net, it sounds like you took a loss on the other piece of common, but this one's got a write-up and is going to net out, so it probably didn't have a huge impact to book value? Is that (multiple speakers)?

That's exactly correct. The only slight correction is that we had preferred before and we have common today.

Understand. And you took out the senior, in this case, to control your own investment?

Correct. That's correct.

And we now own 100% of the common.

All right. That's all I've got. Thanks, gentlemen.

Your next question comes from Arren Cyganovich.

Thanks. Just touching on the environment again, you had solid investments this quarter, although some with secondary purchases. Can you talk a little bit about pricing? You mentioned some volatility, though not quite as big as in the primary markets. But could you talk a little bit about the pricing and opportunities that you have for your existing pipeline?

Sure. We tend to examine investment opportunities where we can earn a low to mid double-digit total return. That can be comprised of the combination of fees, warrants, equity co-investment, or, in most cases, the majority that is in [straight rate].

So, there's not really a measurable market for what we do, as you know. The closest proxy, and the one that we look at, is the liquid loan market, although the liquid loan market tends to be much more influenced by sort of these liquid market players who are interested in first lien, senior secured, true bank loans, the types that have inventory and receivables and things like that as security.

We tend to get involved in capital structures where our capital can be priced at a higher all-in return than you would be afforded in a typical secured bank loan market. In some cases, that would be a second lien loan, one that we structure, one where we take a security interest in assets other than the inventory and the receivables that would typically go to a revolving credit or a first lien bank. In some cases, it's subordinated or unsecured debt.

The key for us is to make sure that within the documentation of each structure we're afforded the appropriate risk controls on the business -- covenants, fees, maintenance tests, board observation rights, whatever the array of different controls that we would have over the operations of the business in terms of observing and monitoring the credit closely.

So when we think about our returns, again, the original premise is we tend to be in that teens -- low teens returns business. And what we do is by having so many -- such a broad array of opportunities to choose from is we try to whittle down those where we can have the greatest risk controls. And that goes all the way back through our due diligence process in any particular loan that we make.

So the markets are not so much choppy as at the moment the first lien market has pretty tight spreads. I think that's a function of government action in the marketplace, low levels of Libor, lots of cash on the sidelines, people looking for shorter-dated floating rate assets. And that really does affect that liquid credit market, that liquid senior loan market that we closely monitor as a proxy for what we do.

But the correlation, while it exists, is not a 100% correlation. There's always opportunities out there. We're always examining opportunities where we could put our capital to work in good risk-adjusted returns in those low double digits.

I don't know if that exactly answers your question (multiple speakers).

No, I understand how you guys work in the market, but I guess I was just thinking in terms of the opportunities that you see within your parameters. So within those low double digit type of returns and the covenant packages that fit your risk parameters, what are -- I'm assuming those have to change from time to time, and I was just curious as to are those opportunities more robust today or are they less robust? How are you seeing your opportunities?

The way I would describe it is I'd echo something that Jim said in the prepared remarks, which is that this is a slow time of the year. It's a seasonal business. We expect there will be a pick-up in terms of transaction velocities, sort of after the August slowdown is concluded. At the moment, as we look at our pipeline report, the types of companies and the types of opportunities that exist in our pipeline report today are not significantly different, vis-a-vis credit or pricing, than those that have been there over the last 12 to 18 months.

I'd say it slightly different. We've been happy with what we've seen over the last 12 to 18 months, but we would have liked to have put more money to work over that period of time than what we were able to. And that continues today. It is an okay marketplace. It's just not a great marketplace. There's not as much activity as we would like to see. And that's why it took us from the beginning of last year through the end of this past quarter to get our leverage from call it 0.24 to 0.64, and we would have dearly liked to have gotten there faster.

Again, it's an okay market. It's not a great market.

That's helpful. And then, in terms of the repayment expectations for the third quarter and kind of the slow investment pipeline, you still feel comfortable with your track towards a higher NII? Is that partially due from the prepayment fees that you're expecting on those, or I guess in terms of --?

Certainly, we expect to have a substantial prepayment fee in the third quarter, and that will have a significant impact on NII in the third quarter. So yes, we do feel very comfortable about that.

In terms of actual net assets at the end of the third quarter versus the end of the second quarter, we have said in two prior conference calls that we didn't expect we were going to have any growth, and in both cases, we ended up having growth in net assets in both the first and second quarter.

Facing the repayments that we're facing in the third quarter, one might think that we might be down in terms of assets, but I'm really reluctant to make anymore forecasts having been wrong in the first two quarters of the year. And largely, because of timing, but that aside, it's still a very hard business to predict because it's lumpy.

That's fair enough. Thanks a lot.

(Operator Instructions). Your next question comes from Rick Shane.

Hey, guys. Thanks for taking my questions. I actually need to learn to buzz in faster than Troy and Jonathan. My questions have been asked and answered. Thank you.

Thanks, Rick.

And I'm showing that there are no further questions in the queue at this time.

Once again, we'd like to thank you all for participating. And, as I like to say, we're here and available if you have any further questions.

Thank you.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.