BlackRock Capital Investment Corp (BKCC) 2012 Q4 法說會逐字稿

Good afternoon. My name is Ginger, 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 hosts 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.

Thank you. Welcome to our fourth 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 lists 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've 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 March 2013 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.

It has been a busy 2012 for BlackRock Kelso Capital. We are pleased with our performance. Our adjusted net investment income of $1.08 per share compared with dividends of $1.04 per share. During the year, we invested $317 million across six new and several existing portfolio companies. Sales, repayments and other exits totaled $315 million. Of that total, investments made during the fourth quarter were $79 million, while exits during the period totaled $111 million.

We worked very hard to keep our total assets where they were one year ago. We are pleased that we were able to accomplish this without lowering our average yields or substantially changing the risk profile of our portfolio. This effort was a big challenge in a bull credit market, in which many of our successful investments were repaid or exited. In other words, a lot of work to stay even.

The US credit markets continue to be driven by reaching for yield. This environment of sustained near zero interest rates has fueled continued and increasing demand for higher yielding assets and for risk assets more generally.

As for the supply side of the equation, new private equity transactions remain slower than we had anticipated. As a result, supply of capital exceeded demand. This excess supply has been directed to other types of transactions, such as issuer-friendly opportunistic loan repricings, upsizings, and dividend recapitalizations with higher leveraged levels and weaker credit protections. We operated in a difficult market, which we expect to continue.

In 2012, LBO purchase price multiples tracked by S&P averaged over the 9 times EBITDA on average deals greater than $500 million but less than 8 times for transactions less than $500 million. The ratio of debt-to-EBITDA averaged 5.5 times for larger deals and 5.0 times in the middle market. In other words, the middle market remains relatively attractive.

Given the current market conditions and our focus on capital preservation, we continue to be very selective. We have avoided transactions where deal structures are weak, leverage is too high, and returns are not adequate to appropriately compensate us for risk.

In the fourth quarter, our aggregate portfolio size was reduced by $32 million. Our leverage stood at 0.5 times at December 31st, a slight reduction from 0.55 times at the end of the third quarter.

We have plenty of debt capacity to grow our portfolio, without needing to issue additional equity capital. At quarter end, we had more than $203 million available under our existing revolving credit facility and during the quarter we received commitments to increase and extend the maturity of a revolving credit line. In addition, we closed $115 million convertible notes offering, which Mike will describe in a few more minutes.

As always, we remain focused on our dividend coverage. For the quarter, we had net investment income of $0.27 per share adjusted for pro forma incentive fees. Yesterday, our Board of Directors declared a quarterly dividend of $0.26 per share, payable on April 2nd to stockholders of record on March 19. For the year 2012, we produced adjusted net investment income of $1.08, related to dividends of $1.04 per share.

While it is certainly a challenge in today's environment, we remain confident that we will be able to continue to earn net investment income that supports our dividends.

Mike will now discuss our results in more detail.

Thank you, Jim. Good afternoon and thanks for joining our call today. I am pleased to have the opportunity to talk about some of our financial results and to discuss portfolio strategies.

In advance of the conference call, we posted our quarterly investor presentation through our website. The financial section of the presentation starts on page eight.

With respect to the operating details, our portfolio generated investment income $37.9 million for the fourth quarter, compared to $40.7 million for the quarter ended September 30th. This brought total investment income to $147 million for all of 2012. This is a 12% year-over-year increase compared to 2011.

The average balance of our total investments at cost was over 7% higher in 2012 than 2011. The higher average earning asset base, as well as the slightly higher weighted average yields on the comparative portfolios, are contributors to the increase in investment income over the prior year. The weighted average yields of the debt and income producing securities in our portfolio, on a cost basis, were stable at 12.2% at year end.

Fee income for the fourth quarter was $4.4 million and $20.7 million for all of 2012. That compares with $21.9 million for the year that ended December 31st, 2011. The current portfolio provides us with a stable base of net investment income, regardless of new investment activity, and regardless of associated fee income.

Fee income also tends to be relatively consistent over time for the business, although it can be somewhat lumpy when examined from quarter-to-quarter. We earn fees not only for prepayments but for new transactions, amendments, and other fees as well.

Adjusted to remove the effects of fees in each quarter, our total investment income for the fourth quarter was $33.5 million, up from $31.7 million in the third quarter. Included in fourth-quarter net investment income is a $2.5 million cash dividend relating to our investment in M&M Holdings. Excluding all of our fee income and our fourth quarter pre-incentive fee, net investment income was $0.29 per share or $0.25 per share when dividends received during the quarter are also excluded.

Total expenses for the three months ended December 31st, 2012, were $29.6 million, while total expenses for the third quarter were $16.8 million. Of those totals, for the fourth quarter $5.6 million was related to base fees, versus $6 million in the third quarter.

The largest quarter-to-quarter difference was related to incentive fees. Total GAAP incentive fees for the fourth quarter were $17.3 million. With respect to incentive fees based on income, $17 million was earned in 2012 versus $11.9 million for 2011.

The increase is largely due to higher overall portfolio returns, which moved from 11.4% to 12.8%. Of those GAAP incentive fees, $2.5 million in the quarter and $5.5 million for 2012 represent management fees, incentive management fees that are accrued based on a hypothetical capital gains calculation, which GAAP requires. It should be noted however, that capital gains fees, if any, are neither earned nor due in payable until the end of the annual measurement period.

Now on the other hand, pro forma incentive fees for the fourth quarter were $5.6 million, up slightly from $5.0 million for the third quarter. An illustration of the net investment income, it takes into account each of these items, can be found on page 17 of our investor presentation.

Turning to the investment portfolio itself, during the three months ended December 31st, 2012, we invested $78.6 million across two new and several existing portfolio companies. The new portfolio company investments include $20 million invested in the senior secured notes of American Piping Products, which is a distributor of specialized, heavy wall, seamless steel pipe and fittings, and we invested $21 million in the senior subordinated notes of Higginbotham Insurance Agency, which is a generalist insurance broker, placing property and casualty and life insurance, as well as providing risk management services.

We also purchased $1.5 million of equity, representing just under 1% ownership of the Company.

Some of the more significant investments made in existing portfolio companies, included $17 million of par amount in additional borrowings under the second lien loan made to MCCI. This supports a transaction where Humana made a significant investment in the Company. $15 million of par amount in an upsizing of our existing first lien loan at Medimedia was also made during the quarter.

Exits totaled $111.3 million during Q4. Significant repayments included two first lien loans and two second lien loans. The first lien loans were $44 million to Volume Services and $24.6 million to Grocery Outlet. The second lien loan that had been repaid during the quarter included $20 million of par amount to Renaissance Learning and $15 million of par amount to Potters Holdings. For each of these, all four of these transactions, we produced a cash-on-cash return, or an IRR, in excess of 13%.

We had no investments on nonaccrual at year end, compared with one investment on nonaccrual at September 30. Since year-end, we've been actively engaged in the restructuring of two portfolio companies, at least one of which we anticipate will result in a nonaccrual as of the end of our current first quarter of 2013. The weighted average rating of our portfolio companies at year-end was 1.20 up slightly from 1.17 on September 30.

Since year-end, we've experienced some portfolio repayments which have contributed to a slight net reduction in our overall portfolio so far this quarter. Given our current investment pipeline, our expectation is for another slightly negative quarter overall for a net new investment.

As Jim mentioned, we've undertaken two transactions during the first quarter of 2013 that improve our access to debt capital and extend our debt maturities. First, we closed an offering of $115 million in aggregate principal amount of 5.5% unsecured convertible senior notes that are due in February of 2018.

Also this week, we finalized commitments for an extension of our revolving credit facility to March of 2017. The revised revolver will be $350 million of commitments, versus $275 million today. Borrowing costs on the new revolver are lower at LIBOR plus 2.5%, compared with LIBOR plus 3.25% previously.

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

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

Continuing our positive earnings momentum, net investment income totaled $8.3 million and $73.7 million or $0.11 per share and $1 per share respectively for the three months ended and year ended December 31st, 2012. Our portfolio continues to produce a stable amount of interest and dividend income, relative to its size, and an income based incentive management fee continues to be concentrated in the fourth quarter producing an uncharacteristically low net investment income per share relative to that for the entire year.

The percentage of our portfolio comprised of senior loans and notes has remained somewhat stable at 70%. Of this 70% senior debt total, 25% senior notes and loans were secured by first lien, 49% were secured by a second lien, and 26% were senior notes.

In addition, 16% of the portfolio was invested in unsecured or subordinated debt securities, 13% in equity investments, and 1% in cash and cash equivalents. Our average portfolio company investment at amortized cost, excluding investments below $5 million, was approximately $26.9 million at December 31st, 2012 versus $24 million at this point in the prior year.

For the year ended December 31st, 2012, the net increase in net assets from operations was $57.4 million or $0.78 per share compared to $76.9 million or $1.05 per share for the year ended December 31st, 2011. Our net asset value was $9.31 per share at year end.

Removing incentive management fees for the current year, our December 31st net asset value per share has relatively consistent with the prior three quarters at $9.61. At year-end we were in compliance with regulatory coverage requirements, with an asset coverage ratio of 295%, and were in compliance with all financial covenants under our debt agreement.

In May 2012, our repurchase plan was extended through June 30, 2013 with approximately 1.331 million shares remaining authorized for repurchase. There are no purchases under the plan during the year ended December 31st, 2012. Since inception of the repurchase plan through December 31st, 2012, we have purchased approximately 1.425 million shares of our common stock on the open market for $9.5 million, including brokerage, commission.

At December 31st, 2012, we had approximately $9.1 million in cash and cash equivalents, $346.9 million in debt outstanding, and subject to leverage and borrowing-based restrictions, $203 million available for use under our senior secured multicurrency credit facility. Relative to our $1.1 billion portfolio at fair value, we continue to have sufficient debt capacity to grow our business.

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

Thanks, Corinne.

We're proud of our fourth quarter and full-year performance. As we look into 2013, we remain optimistic. We're focused on continued prudent portfolio growth adhering to our conservative investment philosophy, focusing upon preservation of capital.

On behalf of Mike, Corinne, Larry, and myself, I'd like to take this opportunity to thank our investment team for all their efforts and thank you for your time and attention today.

Operator, will you now please open the call to questions? Thank you.

(Operator Instructions)

Your first question is from Rick Shane from JPMorgan.

Hey, guys, thanks for taking my question. When we look back in the history, and again, a lot of this is a function of timing, but there has been a series of realized losses on the portfolio over the last couple of years.

You've been able to, over the last three years, put money to work in a much more attractive environment. Do you think we are now approaching the inflection point, where that'll reverse and you'll start to generate some realized gains going forward?

Sure. Hey Rick, it's Mike.

Hey Mike.

I think -- hey. It's obviously very difficult to forecast gains, and separately, as we've discussed from time to time, within the boundaries of what's allowable under tax, we tend to be as aggressive as we can to realize taxable losses or tax losses, to shield the income from taxation as we make distribution to shareholders.

So whether you're considering this a timing question for BDCs generally, or more specifically to us. With respect to us, we tend to take losses as early as we can, as aggressively as we can. Usually, and we have a pretty good history of having written down the investment prior to taking the loss, and we've been through that before.

At the moment, because we have done that, because we've gone through that active process, we actually have appreciation, net appreciation of the small amount in our portfolio.

So, while this is just a hypothetical, based on a hypothetical liquidation of the portfolio at 12/31, based on the valuations, that would suggest that there would be some gains embedded in the portfolio at that point.

I think adding to that, we have a number of equity positions that do have significant gains in them, and in terms of the timing of realizing those gains, we are not, in most cases, in control of the timing. There are a number of situations that could, I underline could, be realized during the course of 2013.

Got it. Now, look, you're right in terms of marking them to market, it is interesting, there have been substantial realized losses, but over -- the book was marked to reflect that a long time ago, and so it has not continued to impact NAV.

It's just a question, I mean, look -- it's a cyclical business, we understand cyclically why investments that you made '06-'08 timeframe would be investments that you will be existing, realizing losses on. Now as you start to enter a period where hopefully you're harvesting post crisis really incredibly stringently underwritten investments that you could see the other part of that cycle.

I think in some ways you are more likely to see it from that period, from the earlier period of time, where companies were restructured and we ended up with some significant equity, and that's what you will most likely see the significant gains.

Got it. That makes sense too. I haven't even thought of that.

To add on to Jim's point, we often use our investment at ECI as an example of that. We have realized long ago. We realized, not only wrote down in fair market value, but realized a loss on ECI, but we continue to hold the securities.

We realized the loss, because for tax purposes, we were able to shield income in that period. We reduced our basis in the asset. However, we still have the asset, and in fact, the fair market value of it today exceeds what the initial price was that we paid for the debt investment in the first place.

Got it. I should jump back in queue, because I am sure there are other folks who have questions as well. Thank you, guys.

Sure.

Your next question is from Greg Mason from KBW.

Great. Good afternoon, gentlemen. You mentioned you had two portfolio companies in restructuring. I am going to guess that's Dial Global and Bankruptcy Management Solutions based on the marks this quarter. First off, is that reasonable to look at the -- coming up of those two based on the marks?

And second, those marks are at December 31st. Has the situation deteriorated since then where you think there could be additional negative marks in the first quarter?

Hey Greg, it's Mike again. Those are not unreasonable guesses, we'll start with that.

All right.

And, with respect to each of those situations, they are both at different stages of a negotiated restructuring of our investment. Each of which will take its own series of turns along the way, and again, it's a good time to think about the same example I just used with Rick, which was ECI.

That's a company that we took through a restructuring. We started out with debt securities. We did some restructurings. We ended up with equity securities, where we, together with somebody else controlled the business and control the board.

It's quite possible that in at least one of those cases, a similar outcome will happen, where we will trade some equity securities for some debt securities. We may participate in other layers of the capital structure along the way.

We'd become already much more active in guiding at the course of the business operations and the ultimate outcome of the situation. That's our downside control. It can be a bumpy ride along the way from a valuation perspective, but we continue to look at the long term of what we started with, what we're taking the Company through, and what we expect to get when all of the dust settles. And again, while neither of those two companies is exactly in the same situation as ECI for another example, that's kind of the framework under which we do these things.

So having said that, you know our valuation process and policy. We don't actually prepare the valuations at our level. We only review the third party work that's done by our valuation providers. So it's really up to them, and they're going to look at all the inputs I am sure, as they always do, and those situations continue to evolve. So at March 31, whatever the inputs are, the inputs will be, and they will take that -- their same exact procedures and move forward.

Okay. Great.

Jim, I don't know if you want to add to that.

The only thing I would say is it would be hard to characterize that either businesses have deteriorated since year-end.

That's a fair point. The operations underlying the investments are somewhat consistent over the last several months, if not improving.

Okay great. Thanks, and then one additional question. You took or you had to for GAAP purposes, account for an increase in the potential realized gain incentive fee, even though that's a hypothetical, but I was kind of confused given, I believe there was a net write-down this quarter in the portfolio, was surprised if there was actually an increase in that cap gain accrual versus what I expect it to be a reversal. Can you talk about that a little bit?

I would -- it's Mike again, I'd ask Corinne maybe just to follow-up on the high level of comment that I'm about to make, which is that also in the period we had a realized loss and the GAAP addresses the amount of the unrealized appreciation, I believe, and those two things don't exactly net for the way the accrual works for the GAAP accounting, but Corinne could probably give more detail on that.

Yes. That's exactly right, and also for the measurement periods is slightly different. So I'd be happy to take you through the details of the nitty-gritty accounting offline, but the way Mike characterized it is right, you have an appreciation that's offsetting on a hypothetical liquidation, and the only thing I could point you to in our case today, it's $20 million of net appreciation that's disclosed, which is part of the driver to that answer.

Okay. Thank you guys.

Your next question is from [Ron Jusica] from Wells Fargo.

Thank you for taking my question. I just wanted kind of a high level view on new originations. It looks like they focused a little bit more on second lien when one compared to exits in the quarter. I was wondering if that was a relative value or just a small sample size?

I think it's precisely neither, but it's much closer to just a small sample size. We have two investments in new companies that we made, we balanced those with some add-on investments in existing portfolio companies. Obviously that's based on what the opportunity set is over any 90-day period as opposed to some macro call on capital structure arbitrage or anything else like that.

Okay. And then if I could just have another quick follow-up on Dial Global. I saw there some talks about a proposed restructuring, and it looked like the second lien would be -- about 60% of your second lien will be restructured into equity, I was wondering if that would be a preferred position or a common position under the current proposal.

Well again it's unfair to say anything definitive at this point, but the likely outcome in this situation is that, we're going to exchange our current second lien loan position for some new second lien loan and some equity, and yes in fact, the current construct has that equity becoming a preferred equity security with an accreting dividend.

All right. Thank you very much, and congratulations on the quarter, guys.

Thank you.

Your next question is from Arren Cyganovich from Evercore.

Thanks. I just wanted to ask about the potential for a slowdown in repayment activity. I know you said already that this quarter is exceeding your investments by a small amount, but looking at your portfolio, I think there's now only 17% of the portfolio is kind of pre-2010 vintage. Just your thoughts about either I guess maybe what is expected to pay down normally, and then may be on the prepayment front out of the portfolio.

Sure. Obviously our vision on prepayments is now 2020 over the long term. But we do have some sense of what's coming in the near term on either announced transactions or transactions where we're in discussions with somebody.

With respect to that latter category, I go back to what I said in the prepared remarks, which is that so far, quarter-to-date, we've had some repayments and prepayments of some existing loans, and as we stand today in the quarter, we're slightly net negative and we expect to be slightly net negative on a net new investment basis. So that would mean we've been repaid or prepaid on some additional assets this quarter.

It goes with the territory, as you have seen over time and as we have seen over time. Some of our most carefully underwritten transactions, where we are able to earn excess returns, are some of the first deals to get refinanced in a bullish credit market, because now that the Company has performed well and the rates are so high relative to where we sit in the capital structure, we can only enjoy that advantage for so long, before somebody comes along and offers the Company a refinancing.

Sometimes that's a transaction with which we can be involved, and sometimes it's just not that attractive for us to reduce our rate or extend our risk and stay in the deal. So a longer winded answer perhaps, most of the prepayments we would think would be behind us after this quarter settles out.

Although, that being said, it is very hard to predict, and if you just look back over the last couple of years, sort of order of magnitude off of the $1 billion, $1.1 billion portfolio, repayments have run about, call it $300 million, $300 million plus, two years in a row. So I think if you use that as a proxy, it's not -- I am not predicting that by any stretch of imagination, I am just telling you what the history has been.

Okay. That's helpful. Then, maybe on the liability side, you recently did the convert, maybe just your thoughts about doing it now. The way that I would think about doing that and taking advantage of that is when you have more net portfolio of growth. I know it helps from the liability duration side, et cetera, and it better matches your assets, but just trying to think of, if you have a shrinking portfolio, why go with some more intensive financing right now?

Well, it's a good question and it's something that we consider when we think about doing the convertible offering, or any other debt transaction, liability transaction.

I think the overwriting, most important, as you rank them, thing for us to focus on, is making sure we have adequate duration liabilities, and we really did two transactions in conjunction with each other. The convertible note offering you saw, we executed just last month, and as I mentioned earlier on the call, we can have commitments for an amendment of an extension and an amendment of our revolver, and we think of those things in concert. So we lay out when we have different lines of credit expiring.

We always like to have sufficient visibility, longer term, longer duration liabilities. And earlier in the prepared remarks, I mentioned that we reduced the pricing on our revolver pretty significantly, 75 basis point reduction in price there, as well as an increase in the availability under the revolver.

So when you look at the two transactions put together, we are very, very pleased with what we accomplished, which was to extend the maturities, increase availability, and it doesn't, other than some transaction fees, it's only a slight increase in our overall cost of capital.

I guess, what I would say is also, as I mentioned before, we have a net increase in portfolio of about $2 million this year, and we are optimistic about 2013, and we would hope to grow that portfolio. So with that in mind, we think that that the capital raise has made a lot of sense.

Okay. So I guess, that's fair enough, I appreciate the thought process there. And then with the backdrop of the environment that we're in right now and the near term expectation it is going to hold, it strikes me to be a little bit optimistic to expect portfolio growth, crossing the equal in this environment.

Well, I don't think the environment in 2013 is much different from the environment in 2012. This has been going on for some period of time now, and as we are -- we're very close to this there are a couple of transactions we could have been up $50 million or $100 million, so it's -- and we could also have missed a couple more, and down by $50 million. But I think it is realistic to think that we will be able to get some growth into the portfolio of 2013.

Okay. Thank you very much.

(Operator Instructions). Your next question is from Douglas Harter from Credit Suisse.

Thanks. My question was asked and answered. Thank you.

No further questions at this time.

Well thank you very much for joining us today, as I would like to invite you all if you have further questions to get in touch with us. Thank you.

Ladies and gentlemen, this does conclude today's conference call, thank you for participating. At this time, you may now disconnect.