BlackRock Capital Investment Corp (BKCC) 2013 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 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 B. Paredes. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer session.

(Operator Instructions). Thank you. Mr. Maher, you may now begin the conference.

Thank you, Ginger. 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 have posted to our website an investor presentation that contemplates 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 2014 investor presentation link in the presentations section of the Investor Relations page. With that I would like to turn the call back over to Jim.

Thanks, Larry. Good afternoon and thank you for joining our call today.

We were pleased with our performance in 2013. Highlights include new investments in excess of $500 million, substantial increase in the valuation of many of our equity positions and an increase in net asset value to $9.54 per share. Full-year 2013 net adjusted investment income of $0.92 per share taken together with our portfolio net realized and unrealized gains substantially exceeded our dividend and resulted in an increase in net asset value per share of $0.23.

We concluded the year with a solid fourth quarter. We invested nearly $170 million while sales repayments and other assets totaled $123 million.

The quarter brings our originations for the year to $534 million. Our adjusted net investment income was $0.22 per share for the fourth quarter and we had net realized and unrealized gains of $26.7 million.

During 2013 and into the beginning of this year economic conditions and the performance of our portfolio companies both continue to improve. As we look at new investment opportunities we try to balance these strong economic fundamentals against the weak credit market technical factors.

Market conditions remain challenging particularly on the upper end of the middle market for investments and sponsored back M&A transactions. 2013 was characterized by record inflows of capital into debt funds. Loan funds have benefited from consecutive weekly net inflows for 89 weeks increasing the supply of capital particularly for large transactions with market liquidity.

Deal flow improved throughout 2013 but never reached the more robust levels many, including ourselves, had predicted. Overall the trend toward somewhat lower rates, higher leverage levels and more issuer-friendly structures seen in the first three quarters of 2013 continued into the fourth quarter and still persists today.

We've been very focused on the high risk-adjusted returns of our current equity investments. A substantial portion of these equity investments were acquired through active distressed investing and restructuring.

As a result these equity investments often have attachment points that are far more attractive than current high-yield bond offerings. As we have said on our past several conference calls we have been actively managing certain of our existing appreciated equity positions toward exits.

Earlier this year we exercised two tranches of our Arclin warrants and subsequently entered into an agreement to sell our entire debt, equity and warrant positions for an aggregate proceeds of $59.2 million. This transaction will generate a realize gain of $37.2 million. Anticipated proceeds will be $7 million above our yearend mark for this investment.

Another of our larger equity investments is currently in the final stages of a sale process at a price that would produce a significant gain to us. We anticipate that this transaction will close in April. Together these two investments represent nearly half of our equity exposure as of December 31.

Utilizing loss carryforwards to eliminate the capital gain distribution requirement will allow us to reinvest the proceeds from these transactions in interest-bearing securities. We expect to redeploy these sales proceeds over time and to temporarily reduce our current followings.

Notwithstanding these profitable exits we expect to continue to hold a substantial majority of the remainder of our equity investments over the near to medium term. With respect to those positions we continue to hold we expect that the rate of return on these investments will continue to exceed the risk-adjusted returns that we can earn by reinvesting the proceeds.

Finally, during the year and in the fourth quarter we were able to increase our borrowings to move closer to our goal of approximately 0.75 times leverage. At December 31 our leverage stood at 0.67 times.

Even after our $534 million of new investments in 2013, we continue to have sufficient debt capacity with which to grow our portfolio further into 2014. As a result we still don't expect to raise additional equity capital in the near term. Mike will now discuss our results and portfolio activity in more detail.

Thank you, Jim. In advance of this conference call we have posted our quarterly investor presentation to our website. An overview of our fourth-quarter results starts on page 2.

We are pleased that our investment portfolio grew to more than $1,200 million at the end of the fourth quarter. Net assets stood at $710 million and net asset value per share increased by $0.16 during the quarter to $9.54 per share.

With respect to earnings our portfolio generated investment income of $33 million for the fourth quarter, which was an increase relative to the $31.4 million in the prior quarter. The increase in investment income in the fourth quarter resulted from slightly lower interest income more than offset by higher fees on a quarter-over-quarter basis. And as a reminder, the income tends to be relatively consistent for our business over the long run although at times it can be somewhat lumpy from quarter to quarter.

Total expenses for the three months ended December 31 were $28.4 million compared to $22.5 million in the third quarter. The principal difference between these two periods relates to incentive fees including those accrued on unrealized gains.

Incentive fees relating to income were $9 million in the quarter and incentive fees accrued based on hypothetical capital gains calculation were $5.5 million. With respect to incentive management fees based on income, $10.9 million was earned for the annual 2013 period versus $17 million for 2012.

On a pro forma basis incentive management fees for the fourth quarter were $2.5 million up slightly from the $2.1 million in the third quarter as adjusted. Of the current period totals $5.5 million in the quarter and $20.3 million for 2013 represent incentive management fees accrued based on a hypothetical capital gains calculation as required by GAAP.

It should be noted, however, that capital gains fees, if any, are neither earned nor due and payable until the end of the annual measurement period. The total accrual at the end of the current quarter is the result of $130.5 million of net unrealized appreciations on the balance sheet as of yearend.

We believe that our adjusted net investment income, which removes hypothetical fees and adds an adjustment to account for incentive fees earned on income is the better indication of our quarterly performance. A reconciliation of these GAAP and non-GAAP measurements appears on page 11 of our investor presentation.

Adjusted net investment income of $16.5 million in the quarter compares with $16.1 million in the third quarter and equated to $0.22 per share. Throughout the past year we increasingly focused our origination efforts on a combination of higher quality investments and special situations where we had investment edge or benefit as a result of experience, information, relationships or in most cases all three. We look at new opportunities and current environment with a long-term view.

We focus on maintaining and growing our NAV over time. Our investment strategy does not favor portfolio growth at the expense of lower credit underwriting standards that we believe don't benefit our shareholders over the long run.

Generally, current market conditions have led us to focus on higher quality senior loans often with some significant credit support from asset coverage. We continue to seek investment opportunities where we are able to capitalize on the premium afforded to middle market transactions for reduced liquidity.

Capital deployment during the quarter was focused on investments in new portfolio companies comprising more than $145 million of our originations for the quarter. Some of the more significant investments made during the quarter included $60 million in Quality Home Brands Holdings, or QHB, and the second lien term loan and holding company term loan.

The investment was split between $40 million in the operating company and $20 million at the holding company. We earned $1.8 million in capital structuring fees in conjunction with the transaction. QHB is a leading designer, manufacturer and supplier of decorative, functional and specialty lighting products.

We also invested $25 million in the senior subordinated notes of Automobile Protection Corporation, or APCO, which is a marketer and administrator of vehicle service contracts. We invested $21 million in a senior secured first lien term loan to Accriva Diagnostics and we earned a $400,000 capital structuring fee in conjunction with that transaction. Accriva is a medical device manufacturer which sells point-of-care diagnostic devices to hospitals and physicians offices.

We also added $15.8 million of additional subordinated needed notes to Higginbotham Insurance Holdings. Approximately 80 potential transactions were reviewed during the quarter resulting in investments overall in nine new portfolio companies. While this is an unusually high success rate we were fortunate that four of this quarter's nine investments were made in existing or passed portfolio companies.

In conjunction with portfolio company exits we recorded fees of $1.6 million in the quarter. This brings our total fees earned in conjunction with exits to $8.1 million for 2013. During the fourth quarter we also realized fees of $3.2 million in conjunction with the portfolio company investments.

We continue to look to make commitments in the capital structures of businesses in which our investments are well supported by future free cash flow generation, current enterprise value and identifiable assets. We view this as a defensive posture. We expect to continue seeking these more conservative investment structures.

In general, our portfolio companies are performing quite well and many of our former problem children continue to see improvements in operations or in their capital structures, or in many cases both. As we mentioned in our prior earnings call we were able to exit our investment in Dial Global during the fourth quarter realizing a value slightly above its September 30 fair market value.

We had no investments on non-approval at quarter end. The weighted average rating of our portfolio companies at the end of the fourth quarter was 1.14 compared with 1.11 on September 30. And with that I would now like to turn the call over to Corinne to review some additional financial information.

Thanks, Mike and hello, everyone. I will now take a few moments to review some of the other details of our 2013 fourth-quarter financial information.

At yearend 2013 compared to the prior quarter the composition of our portfolio invested in senior secured loans decreased 5% to 43% while our unsecured subordinated debt securities increased 5% to 16%. Our equity investments climbed 1% to 22% at the quarter end resulting primarily from continued appreciation in our existing investments. This is a further climb in our non income-producing securities from 13% at last yearend driving the 20 basis point decrease in our total portfolio yield for the year.

For the year ended December 31, 2013, our net investment income as adjusted is $0.92 per share as compared to $1.08 per share one year earlier. The decrease is due to exits of some of our higher-yielding assets in the recent quarters, a higher percentage of our equity securities in the portfolio and lower fee income in 2013 compared with 2012.

The weighted average yield of the debt and income producing equity securities in our portfolio at the current cost basis was 12% at December 31, 2013, and 12.2% at December 31, 2012. The weighted average yield on our senior secured loans and other debt securities at their current cost basis were 11.4% and 13% respectively at December 31, 2013, versus 11.4% and 13.5% respectively at December 31, 2012.

Yields exclude common equity investments, preferred equity investments with no stated dividend rate, short-term investments and cash and cash equivalents. Relative to our $1.2 billion portfolio at fair value we continue to have sufficient debt capacity to deploy in attractive investment opportunities.

At December 31 we were in compliance with regulatory coverage requirements with an asset coverage ratio of 246% and were in compliance with all financial covenants under our debt agreement. At December 31, 2013, we had approximately $18.5 million in cash and cash equivalents, $478 million in debt outstanding and subject to leverage and borrowing-based restriction, $171 million available for use under our amended restated senior secured revolving credit facility, which matures in March 2017. With that I would like to turn the call back to Jim.

Thanks, Corinne. After approximately $46 million of net new investment in the fourth quarter equities comprised 22% of the portfolio at yearend.

As I mentioned, since yearend we have begun to exit several significant equity holdings. After we have exited those investments we still will hold equity positions that comprise a higher percentage of the overall portfolio than is our long-term goal.

On the other hand, we are quite pleased with the performance of the underlying companies and we believe that many of these investments will continue to compound at a rate that exceeds the rates generally available in the marketplace today. That being said we remain focused on additional exits as these investments continue to mature.

We remain patient in the current environment. We remain focused on growing our portfolio and the increasing utilization under our debt facilities.

Dividend coverage from net investment income and equity appreciation remains a priority for us. We are always assessing our dividend coverage from both ordinary income and expected gains.

On behalf of Mike, Corinne, Larry and myself I would like to take this opportunity to once again 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). Greg Mason, KBW.

Congratulations on the nice equity gains. I believe I'd be in-line speaking that the other potential exit in April would be the ECI investment and just curious as that's approaching exit if there is potential meaningful upside from the $69 million fair value at December 31 in that investment?

We are not commenting on which investment it is. I would say that I would expect it to be when we exit that investment it would be approximately where maybe slightly above where we had it marked at the end of the year.

Okay. Great. Perfect color.

And then as we look at your leverage, your net leveraging at yearend was 0.65 debt to equity. Can you talk about what your target leverage is and as we approach that releveraging the balance sheet here what your thoughts are in terms of capital needs going forward?

Sure, Greg it's Mike. In the prepared remarks we mentioned that our goal in terms of leverage utilization is 0.75 to 1.0. We ended the year at 0.67.

Since yearend, Jim mentioned in his remarks, we have agreed to one exit and are looking forward to a second potential exit of an equity position. Certainly that would temporarily lower our borrowing level but our comfort zone remains at 0.75 and that is something that is look to manage toward. It's obviously difficult to do at any one moment in time but as an overarching goal that's where we expect leverage to be and were we feel comfortable.

Great, guys. Thanks. Nice quarter.

Greg Nelson, Wells Fargo securities.

Just hitting on the equity issuance a little bit further. Obviously with the realizations coming in the first quarter, leverage levels are going to tick down, but I'd just like to hear your thoughts on as you look at your dividend yield and as you start to hit higher levels of leverage how you guys would be able to invest and make it accretive to shareholders.

I think the first step, Greg, would be to redeploy a significant portion of the existing equity investments into earning assets. One of the things that we have been focused on over the last several months and continue to be focused on as we look forward into 2014 is the fact that as each of us stated in the prepared remarks and as you see in the financial statements, based on current fair market values equities are about 22% of the portfolio as of 12/31 and obviously those don't typically have a cash yield to them.

So what we're doing is we are earning the dividend on the remaining 78% of the portfolio. And if we can transfer some of that existing equity investment effectively into yielding securities and get the portion of the portfolio that is currently yielding back up to 90% or above 90% of which is our goal, then dividend coverage and increases is pretty easy to pencil out given our current net asset value.

Great. Thanks for the color. And then a couple of questions on credit.

You are booking stuff at higher than market rates, I'd just be curious how you guys get comfortable with some of those things especially in second lien where leverage is a little bit higher -- where leverage is coming out at similar levels. And then on QHB, just how you guys got comfortable with that credit. It's gone bankrupt before, so I'd like to hear your thought process there.

Sure. I guess two separate questions in your question.

The first is that we underwrite each credit individually. We do not do anything top-down or macro in terms of our analysis.

So we are looking with each particular credit to the structure of the transaction, which in many cases we are largely responsible for. We're looking at the quality of the assets, the enterprise value and the cash flow generation of the business. And we look at all three of those over a period of time, we structure covenants and transaction structures to fit that particular situation in each case and then we monitor the credits very very actively going forward so that we can stay on top of any changes and make any sort of appropriate moves along the way.

With respect to QHB in particular, we had examined that company and have followed it since the time of its original syndicated bank loan back before the time of the housing crisis, so we watched it from afar. We were not an investor in -- along the way we monitored the business.

We have a good relationship with the private equity firm that is the sponsor of the transaction. We were able to do quite a bit of due diligence on the company. It has made several changes to its scope of business.

We are investing in it off of a sort of much better capital structure and a much safer macro environment. And we got comfortable based on the fact that the loan is structured into three different components of which we are in the two more secure components. And those two securities that we own relate to each other and to a third more junior security in a way that we got very comfortable with our ability to participate in controlling the outcome.

Great. Thanks very much for taking my questions.

Doug Harter, Credit Suisse.

Thanks. Just wanted to confirm. I think you answered this in the last question but you said that 10% is your long-term goal for equity allocation?

I would say it's really between 5% and 10%.

And obviously you said you will be looking to exit a couple of positions in the near term, but how should we think about the pacing to get to that goal?

We have four other positions that are over $20 million at the moment. And then the rest of them are 5s and 10s for lack of a better description.

One of the 5s to 10s is up for sale at the moment. I would expect in the course of 2014 that maybe one or two others of those may be sold.

I would also expect, although there is no activity at the moment, on any of the 4s that are over $20 million. But if I had to guess I would say that one of those transactions will probably be realized here in the course of this year, so you can add that up. But that's a real real rough estimate.

I would only add to Jim's remarks by saying that when we are aware that a company is put up for sale as is the case of the one example Jim was referring to, obviously we have some sense of timing around that type of a transaction. With respect to the others we are not in control exclusively of the -- we're not the controlling equity shareholder of any of those businesses.

So we can't make something happen but obviously we very closely observe the performance of the companies and we are very active in the market. And so we do have a good estimate or idea sense of what may happen.

And obviously this is a very good market for selling companies with improving performance in the middle market in leverage finance transactions. And when you go through the list that Jim was referring to anyone can make their own assumptions but many of those companies fit that type of a description.

I guess I would add to that that the investors in those companies tend to be of like mind. When they have had a really good -- when they approached maturity, I think, they tended to be liquidated.

The two investments that we have sold, at least in our minds, had reached a certain level of maturity. Those investments, by the way, during the course of 2013 through the closing of those transactions will have generated during that period of time roughly $40 million of unrealized appreciation until it is realized.

So there's a sort of sense of maturity that is implicit in each one of these investments. Some of the bigger investments that we still have I think have a little ways to run before it makes sense to sell them, i.e. we think the returns on them are going to be pretty good.

Great. Thank you for that color.

Evan Keefe, Prudential Financial.

I actually had a question regarding your 40-APP application earlier in the year with respect to 52nd Street Asset Management. You say you're going to manage CLOs there.

I'm just kind of curious is that going to be CLOs from the private debt that you already have on your balance sheet versus more syndicated flavor? And how do you see 52nd Street ultimately affecting your net investment income and being accretive to shareholders?

Sure, Evan. I think the high-level strategic idea behind 52nd Street Asset Management is that obviously we have an application pending with the SEC right now. We hope to have that application approved so that we might begin to participate through that vehicle in the slightly larger, certainly more senior, typically rated bank loans that we see in the ordinary course of our business connected to the types of investments where we would otherwise on behalf of the BDC be making junior debt investments or attempting to at least make junior debt investments, which is to say performing the due diligence and deciding whether or not to participate.

Many of those transactions have attractive senior loans attached to them that don't fit the mandate of the BDC. And the application for 52nd Street and the structure around that would be to be able to manage those types of investments that we see in our ordinary course of business without taking any of the assets that would otherwise be appropriate for the BDC itself, applying a more appropriate level of leverage to those and having the benefit of that invested time and energy that we have made with our deal team go into the BDC's platform through that investment vehicle.

Now 52nd Street of course, should we get the approval, which we expect but are unsure of at this time, should this come to pass that would of course be a separate portfolio company of the BDC. And so to the extent that there is profitability from that undertaking it would benefit the BDC.

Just one quick follow-up, thank you for that color as well, is would you expect that the BDC would also contribute equity to the funds that 52nd Street manages?

I think obviously this is forward-looking but we would hope to certainly be able to invest some amount of the equity or other securities into the structures that 52nd Street might manage because we believe in our ability to do a good job managing those assets and because we are already examining and understanding the types of companies whose securities, whose loans would go into those potential structures. Having said that there are obviously lots of complexity -- there is lots of complexity around both the 40 Act and the accounting rules with respect to how this is all treated so I don't expect we would ever have any kind of majority or controlling or substantial equity investment in the vehicles themselves.

Very good. Thanks very much for taking the time to answer my question.

(Operator Instructions). John Bock, Wells Fargo Securities.

Thank you for letting me hop in and ask a few additional questions. I'm going to tail off of Greg Nelson's questions as it relates to the subordinate debt investments that you've made either second lien or just pure subordinate. Guys, can you give me the average leverage levels that you are originating at in those assets, just broad brushstrokes, please?

It's hard to do because each one is so unique, Jonathan. I think --

A range would be fine.

Even with a range it's a little bit hard to do. I will describe for you what we are seeing generally in the market and by what we are seeing I mean by what we are seeing that is attractive.

Okay.

We think that in solid cash flow businesses where perhaps there is enterprise value coverage but perhaps not asset coverage we tend to see kind of first lien structures to the 3.5-ish an attachment point and we then see either second lien or subordinated debt or a combination of those between 3.5 and 5.0 or 5.25 times. There are outliers both lower and higher in what we are looking at today and there are outliers both lower and higher in our portfolio of recently booked assets.

With respect to transactions where we're looking at them on a more asset-backed basis, where we are looking for security and asset protection, whether in a first lien, second lien, a FILO, a split collateral deal, wherever it is we are going out and we are looking at the appraised value, we are coming to a conclusion about the valuation of the assets supporting the credits. In many of those transactions the leverage can be much higher because we are looking at loan-to-value in those cases really an asset-secured or an asset-supported basis.

And for example many of the energy-related transactions that we have done this year have that kind of asset support as opposed to a leverage level because many of those are projects where you are undertaking to go extract assets, connect assets. Energy is a slightly different type of investment strategy, so again I don't mean to evade your question but strictly looking at those on a leverage basis isn't always appropriate.

And obviously you have known us a long time, you know that we are able to and pride ourselves on finding value in things other than the simple bond market kind of what the rating agencies might pick as, leverage levels or other standardized tests. Each of these assets is somewhat unique.

No, I appreciate that. And I guess I'd say that the genesis of the question is going to be a matter of pure comparison because let's say a good majority of peers that you would hold in high regard tend to focus on first lien, true senior secured debt that carries with it a much lower rate. And perhaps their cost of capital and structures allow them to do that which might not be the case here.

The question is is there additional risk being taken owning subordinated assets. And of course you'd never say yes but if the industry zigs and you zag in a different direction via owning more subordinate credits, however you want to define it, that's just a question clients would tend to ask. And so leverage or other ways that they can get risk is probably -- that's just the question we are asking.

And Jonathan, we understand and I am sympathetic to that because you are correct in so far as the behavior of certain of our peers, many of whom we respect, who are chasing more senior, more first lien lower rate assets in larger amounts. The way that they are achieving their returns is by levering those assets to an extent that is greater than our leverage tends to be because they do things either in a vehicle or off-balance sheet or a combination of those things.

And it's really a question of where you want to take your risk or how you want to take your risk. You alluded to our structure or our cost of capital. It's not really our cost of capital, we borrow as attractively as anybody.

It's our structure in terms of not having off-balance sheet or other credit supported higher leverage methods of financing ourselves. And as a result we tend to need to make our returns on the asset side of the ledger more than on the balance sheet, on the leverage side of the ledger. And we do that by being overly selective and being really active in how we structure these different investments because you are right, this doesn't come for free.

If you are going to get a higher return you really need to invest the time and energy in finding assets where you are able to do that. Sometimes that's smaller businesses, sometimes that's businesses that are in a state of greater transition and sometimes those are more asset supported credits that other lenders in our business tend to overlook. You're right, I don't disagree with your assumption.

And I will say it's appreciated when you kind of give that additional color because people would in light of equity gains and now your also ability to rotate, people can become a bit more comfortable with potential credit risk in light of what you are doing there. So no, I appreciate you taking the time to answer the question. Thank you.

You brought something up in the end of your comment there, Jonathan, which is another good point which is that as we do redeploy this equity our need to earn pure high-yield and higher-yielding yields is somewhat alleviated because we will be earning on a higher percentage of our total assets on a current basis.

I guess the only thing I would throw out is to the extent that earnings go up that's a good thing and of course as the valuation goes up and the yield at which you raise goes down, or excuse me your dividend yield goes down due to an increasing stock price, that helps. However, if we are even looking at a 10 yield held at roughly between 0.6 and 0.7 leverage with the fee structure in place, the cost of capital in our view to the extent that it is raised, or should I say your required rate of return on new assets, it's almost going to be a push if you are thinking about that 10% or 11.5% rate at which you are originating at.

And so we agree growingly NOI is great but also we appreciate your focus on delivering leverage and waiting to raise equity capital at the right time, which you've chosen to do. So just a few, I wouldn't call it a question, just open thoughts on equity capital rates. You guys have been disciplined and that is very much appreciated.

Well, we agree. We are big investors ourselves, as you know.

There are no further questions at this time. Presenters, do you have any closing remarks?

No, I'd just like to thank each one of you for attending the call today and if you have any further questions always feel free to give us a call. Thank you.

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