BlackRock Capital Investment Corp (BKCC) 2017 Q2 法說會逐字稿

Good morning. My name is Greg, and I will be your conference facilitator today for the BlackRock Capital Investment Corporation Second Quarter 2017 Earnings Call. Hosting the call will be Chief Executive Officer, Michael J. Zugay; Chief Financial Officer and Treasurer, Donna M. Milia; General Counsel and Corporate Secretary of the company, Laurence D. Paredes; Nik Singhal, Investor Relations and Business Strategy; and Marshall Merriman, Head of Portfolio Management for BlackRock's U.S. Private Capital Group. (Operator Instructions) Thank you. Mr. Paredes, you may begin the conference call.

Good morning, and welcome to BlackRock Capital Investment Corporation's Second Quarter 2017 Earnings Conference Call.

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 Capital Investment Corporation's actual results may differ from these statements. As you know, BlackRock Capital Investment Corporation has filed with the SEC reports, which lists some of the factors which may cause BlackRock Capital Investment Corporation's results to differ materially from these statements. BlackRock Capital Investment 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 have not been independently verified. Accordingly, BlackRock Capital Investment Corporation makes no representation or warranty with respect to such information.

Please note we have posted to our website an investor presentation that complements this call. Shortly, Mike will highlight some of the information contained in the presentation. The presentation can be accessed by going to our website at www.blackrockbkcc.com and clicking the August 2017 Investor Presentation link in the Presentations section of the Investors page.

Thank you. I would now like to turn the call over to Mike Zugay, who will provide an overview of the business and second quarter highlights.

Thank you, Larry. Good morning, and thank you for joining our second quarter earnings call. I'll start by giving an update on the quarter's business and financial highlights then move to our investment activity during the quarter. Lastly, I will discuss the underlying portfolio performance before turning it over to Donna to discuss our financial results in more detail.

For the second quarter, net investment income was $0.19 per share. Based on the $0.18 per share distribution declared by our Board of Directors, there was approximately 106% distribution coverage. Additionally, net asset value per share increased from $8.22 per share last quarter to $8.33 per share as of June 30, 2017, or a 1.3% quarter-over-quarter increase. Our leverage profile remains low by industry standards at 0.47x, and we have ample liquidity of over $300 million to support new investment activity.

We had a relatively active quarter managing the liabilities of the company. First, we redeemed the entire $17 million outstanding of 6.6% senior secured notes that were scheduled to mature in 2018, then we extended the maturity on our revolving credit facility to June 2022. Next, we issued approximately $144 million of 5% unsecured convertible notes due 2022. There was strong investor demand for our convertible note offering, and as a result, the 15% overallotment option was fully exercised. Finally, we prepaid our $15 million L+3.25% senior secured term loan, which was set to mature in 2019. Our current debt maturity profile, coupled with our strong liquidity position, provides us with operating flexibility for the next several years.

As can be expected with this level of debt capital markets activity, we incurred several onetime expenses related to our debt facility, including make-whole premiums, acceleration of unamortized debt issuance costs and registration statement costs. There was also a onetime insurance reimbursement payment related to a previously disclosed legal settlement, which partially offset these onetime expenses. Excluding these items, NII distribution coverage for the second quarter would have been 114% or rounded up to $0.21 per share.

Later in the call, I will discuss the portfolio in more detail, but as of June 30, 2017, we are pleased to report that we did not have any investments on nonaccrual status. We continue to make steady progress with our goal of restructuring more of the legacy investments and rotating out of reorg equity securities, but we do not have any additional specifics that we can announce at this time. We continue to believe that monetizing noninterest-bearing investments and redeploying proceeds into income-generating assets is an appropriate strategy, but the timing of such moves is inherently unpredictable.

From March 6, 2015, when BlackRock assumed responsibility for managing the investment activities of the company, to the end of the second quarter, our team has deployed approximately $565 million into new investments. As of June 30, 2017, approximately 48% of our current investment portfolio by fair market value is represented by investments deployed by the new adviser. Current market conditions for leveraged loans can be generally categorized as having tighter pricing, higher leverage levels and weaker structures than the recent periods. As such, we remain highly focused on credit quality and disciplined with loan documentation.

As stated on our previous calls, we continue to seek to deploy capital across 3 core channels: Direct investments in junior capital instruments; our portfolio company investment in Gordon Brothers Finance Company; and our portfolio company investment in BCIC Senior Loan Partners, a first lien joint venture with Windward Investments LLC. With regards to BCIC Senior Loan Partners and Gordon Brothers Finance Company, both have underlying investments in diversified pools of primarily first lien loans that generate attractive risk-adjusted returns.

Turning to our investment activity during the quarter. We had a $49.2 million net decrease in our portfolio, as repayment activity, which included proactive sales, exceeded new capital deployment. The repayment activity was primarily represented by 2 transactions: Selling $35 million of the BMS first lien term loan to a third party at par; and a par repayment of our $20 million second lien investment in U.S. Anesthesia Partners, Inc., USAP. The BMS sale was done to rightsize our exposure in this relatively low-yielding first lien term loan. The USAP repayment occurred in conjunction with an acquisition and subsequent refinancing in the broadly syndicated loan market.

Our gross deployments in the quarter were primarily represented by 2 investments: $10.7 million of incremental equity to Senior Loan Partners and $5.9 million of incremental L+11% unsecured debt to Gordon Brothers Finance Company. We had one portfolio company exit during the quarter and now have 34 companies in our portfolio at a fair market value of $893 million. The weighted average yield of debt and income-producing equity securities at fair market value was 11.3% as of June 30. As I just mentioned, we invested $10.7 million into Senior Loan Partners to fund our share of the equity commitment. We are now benefiting from Senior Loan Partners' use of leverage on its incremental investments as it ramps up its portfolio and is now achieving a dividend yield of approximately 11%. Senior Loan Partners made investments into 7 new portfolio companies, which are detailed in our earnings press release. As of June 30, Senior Loan Partners have committed and funded amounts of $177.1 million and $170.3 million, respectively, to 17 borrowers.

On a net basis, our investment in Gordon Brothers Finance Company decreased $7.1 million from last quarter due to timing of investment-related activity that GBFC experienced in the quarter. GBFC's strong origination and underwriting platform continues to provide us exposure to its well-structured asset-based loans. We will continue to support GBFC's growth initiatives as their portfolio expands.

As I mentioned earlier, there are no significant updates with regard to restructuring activity or sales of any of our reorg equity positions, but we continue to make progress on these fronts. We continue to work with relevant parties involved in the SVP investment, as we evaluate options and at rightsizing their balance sheet in order to better position SVP to execute on its 3-year business plan.

Some of the more significant increases in valuations this quarter were concentrated in AGY Holding Corp., SOURCEHOV and U.S. Well. The negative movements were concentrated in Advanced Lighting, MBS and SVP. The valuations for many of these investments are highly sensitive to movements in LTM EBITDA, and most of these companies experienced EBITDA movements which drove the increases or decreases in fair market valuations. In the case of SOURCEHOV, a transaction was publicly announced, which resulted in higher trading levels on the company's debt, which drove the valuation increase. After quarter end, our first and second lien investments in SOURCEHOV were repaid, the first lien at par and the second lien at a 2% premium.

Recently, there was an M&A transaction announced regarding another one of our portfolio companies, Water Pik, and we anticipate our $32 million second lien investment to be repaid in the third quarter, assuming the transaction closes. The robust market environment has led to an increase in repayment activity due to M&A and refinancings.

With that, I would like to turn the call over to Donna for some additional details regarding our financial results.

Thank you, Mike. I will take a few minutes to review additional financial and portfolio information for the second quarter of 2017.

GAAP net investment income was $13.9 million or $0.19 per share for the 3 months ended June 30, 2017. Relative to distributions declared of $0.18 per share, our NII distribution coverage was 106% for the quarter. Excluding $1.1 million of net onetime expenses related to our debt facilities, including make-whole premiums, unamortized debt issuance costs and registration statement costs, net of an insurance reimbursement related to a previously disclosed legal settlement, NII for the second quarter would have been $0.21 per share rounded up, implying a 114% distribution coverage.

Fee income earned on capital structuring, prepayments and administration during the current quarter totaled $100,000 as compared to $600,000 earned during the preceding quarter and $4.1 million earned during the prior year quarter. Excluding fee income and the above-mentioned insurance reimbursement, investment income increased approximately 1% compared to the prior quarter and decreased approximately 16% as compared to this quarter 1 year ago.

On June 13, 2017, we issued a $143.8 million in aggregate principal amount of 5% convertible notes due 2022. The amount above includes the overallotment option, which was fully exercised. The proceeds were used to repay indebtedness under our revolving credit facility and for certain fees and expenses related to the issuance. The 2022 convertible notes will mature on June 15, 2022, unless previously converted, repurchased or redeemed in accordance with their terms. Upon conversion of a note, we will pay or deliver, as the case may be, cash, shares of common stock or a combination of cash and shares of our common stock at our election.

As compared to the comparable 2016 period weighted average, our 6-month 2017 weighted average cost of debt increased 113 basis points to 5.36%. This was primarily driven by: One, make-whole interest incurred in connection with the early repayment of our $17 million, 6.6% notes, and our $15 million L+3.25% term loan; two, lower average debt balances outstanding on our revolving credit facility as a percentage of total debt; and three, higher LIBOR rates for the current period. Excluding make-whole interest and other costs incurred in connection with the 2 early debt repayments, the weighted average cost of debt for the 6-month period of 2017 was 4.75%.

Net unrealized depreciation decreased $3.1 million during the current quarter, bringing total balance sheet unrealized depreciation to $37.8 million. During the quarter, gross unrealized appreciation of $8.6 million was partially offset by $4.6 million of gross unrealized depreciation for a net $4 million of appreciation due to portfolio valuation. Additionally, there was $900,000 of unrealized depreciation during the quarter, due primarily to the reversal of previously recognized unrealized appreciation on the USAP repayment.

As previously disclosed, we announced the waiver of incentive management fees based on income from March 7, 2017 to December 31, 2018. For the 3 months ended June 30, 2017, $2.8 million of incentive management fees based on income were waived pursuant to this announcement. The cumulative amount of such incentive management fees waived since March 7, 2017, is $3.6 million. During the quarter, there was no accrual for incentive management fees based on gains. A hypothetical liquidation is performed each quarter end, resulting in an additional accrual if the amount is positive or a reversal to the existing accrual if the amount is negative. However, the resulting fee accrual is not due and payable until June 30, if at all. There is currently no balance accrued for incentive management fees based on gains as of the measurement period ending June 30, 2017.

At June 30, 2017, we had total liquidity of $409.7 million, consisting of $15.7 million in cash and cash equivalents and $394 million of availability under our credit facility. However, our availability for portfolio company investments is limited to approximately $300 million in order to comply with the 200% asset coverage requirement.

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

Thank you, Donna. We thank you for your participation in today's call, for your continued interest and support. With that, operator, we would like to open the call to questions.

(Operator Instructions) And our first question comes from Jonathan Bock with Wells Fargo Securities.

Fin O'Shea for Jonathan Bock this morning. Congratulations on another -- a good quarter, and it sounds like some positive outcomes following the quarter. Just kind of touching on those, actually, it sounds like you'll get another chunk of capital back, at least, and we're only less than halfway through. Notice in your commentary on the market and nothing being deployed on the core book, can you kind of touch upon what we could expect here in terms of deployment and leverage or maybe even more in the SLP, which -- to that end, it sounds like more leverage will be sourcing upcoming deployments.

Fin, it's Mike Zugay here. Thank you for calling in and thank you for the questions. So look, what we know right now about prepayments, we've got Water Pik out there. SOURCEHOV actually already closed. There was an announcement on another deal that we have in the portfolio. I don't know if that will happen, but if it does, call it $70 million of runoff that we know of. And look, from -- that's what we know right now. So that's -- that pace has definitely accelerated, not to be expected in the market that we're in right now. On the deployment side of things, it -- obviously, that's a little bit harder to forecast going forward. We typically don't give guidance on that, but as you mentioned, the SLP, Senior Loan Partners, we do have capacity to ramp that vehicle up. Our $85 million commitment is our goal, to get to that number, and you could see where we're at to date. So there is room to deploy there. Gordon Brothers Finance Company has -- we have room to deploy there, as well as the second lien deals in the marketplace. What we -- the moves that we have with Senior Loan Partners and Gordon Brothers Finance Company allow us to participate in the really good second lien deals that we do see in the market, the ones where we like the underlying credit. Even if they price in today's market at L 7.75 to L 8, we can still book those deals and pair that up with the 11%, 12% moves that we have on the 2 that I just mentioned, the 2 portfolio companies I just mentioned. So I think -- look, we definitely want to grow the book. It's not -- but we want to grow it in the right manner. We don't want to just deploy and get risk-adjusted returns that aren't quality risk-adjusted returns. So we're going to be patient, but we are actively participating in the markets to deploy where we can. We're just picking our spots.

Sure. And so the core book as well, the second lien, is that -- what was probably the holdback this quarter? And more recently, we -- recently, the focus has been the SLP. So is it pricing, is it structure? Is it sort of relationships, stuff outside of your guys' wheelhouse? Like what's the main driver in terms of holding back deployment?

Yes, look, pricing, structure, those are definitely 2 very important factors at play. There's, to a limited extent, also opportunity cost of our team's time. We've deployed into 17 borrowers on the first lien side of things, and we do the same amount of work on those deals as we do on a second lien transaction. So from the team's perspective, they've been very busy deploying in what effectively now is called 11% returning assets. So there -- that's been better relative value versus where the second lien market is. And now that we're ramped up and we're seeing more of that flow, we're not out advertising to sponsors, "Hey, we're now in the first lien business." People know that we're in the first lien business. So we're spending less time advertising to the marketplace. We're getting more inbound calls on the senior deals. It's definitely freed up capacity to do more second lien deals, but it is going to be -- for second lien deals, the credit quality is of the utmost importance.

Very well. And then just a couple of quick company-specific ones. Very good marks in [KG], U.S. Well. Is that at all -- is that, as mentioned, EBITDA-type movements? Or is this at all indicative of potential activity?

The movements for those 2, it's AGY and U.S. Well. Those were really due to improvements of the underlying portfolio company, the EBITDA improvements.

Okay. And then SVP, which, as discussed in the past, you're actually working on and I, of course, heard you guys, nothing new today, but sort of a technical question on it. How much of that balance is capitalized PIK? And why continue to accrue it given the current mark?

Sure. For this quarter, about $1.2 million was PIK that was capitalized, and the way we treat that is we take a haircut on the PIK if we think there may be a collectability issue. So due to the level of the most recent mark, we set our haircut.

(Operator Instructions) Next, we'll move to Ryan Lynch with KBW.

First, I want to -- you talked about the competitive environment for deploying capital, that there's a lot of pressure on pricing and leverage and structures, and that's evident by the limited growth in your balance sheet portfolio and the limited originations you made in the quarter. However, we did see strong growth in your SLP. So can you just talk about the disparity of attractive investment opportunities that you found for the balance sheet versus attractive investment opportunities found for the SLP? Because I would think if the environment is competitive, it's going to be competitive both in -- in both senior loans and junior loans. And so I would have thought that either we would have saw decent or strong growth in both the balance sheet and the SLP, or limited growth in both the balance sheet and the SLP. But this quarter, we actually saw limited growth in the balance sheet and strong growth in the SLP. So can you just kind of provide some commentary around that?

Yes, look -- Ryan, it's Mike here. A couple of points. Well, first of all, the SLP is focused -- the underlying investments are in first lien loans, and the first lien loan market has not seen the same price spread compression as the second lien market. We're still seeing spreads in the L 4.25 to L 50 range in the middle market. And so you're not seeing the same, call it, 100 basis point contraction that there is in the second lien market. So from a leverage level, from a pricing level, first lien is more attractive in the vehicle than the SLP vehicle, because it's a levered vehicle. So to get 11% returns being in a diversified pool of first lien assets, where, in most cases, all but a couple, we have leveraged covenants and better documents than what we're seeing in some of the larger second lien deals out there. So it -- the first lien market, just to answer your question bluntly, is more attractive right now than the second lien market, in my opinion.

Okay. Well then, to add on to that, if the first lien market is more attractive than the second lien, do you guys ever think about placing some lower-risk but also lower-yielding first lien investments on your balance sheet, if even temporarily, as you guys are underlevered, with the thought process of, "These are lower risk." And then eventually basic placeholder investments, so that eventually down the road, you'll have very limited credit losses for these investments, and then potentially down the road, you could rotate out of those into some higher-yielding second lien reinvestments?

Yes, look, it's something we definitely think about. The only problem with booking those first lien loans on balance sheet, it is -- they're not liquid, right. So when you do want to sell, you really can't. They're a limited-buyer universe for those assets, but it's definitely something that we thought about, even more so on the unit tranche side, so not booking L 4.50% type assets on the balance sheet, but taking some of that lower-risk, L 6.50% type unit tranche product on balance sheet. That is absolutely something that we consider, and we're looking for those assets, quite frankly, in the marketplace.

Okay. And then one last one. Credit has held up well. You guys don't have any nonaccruals, but when I look at grade 4 investments, which were investments for you guys, listed in your 10-Q as -- that are performing materially below expectations, maybe like that jump from about $6 million to $40 million from the first quarter to second quarter. So can you just talk about there -- was there one investment that you guys marked down or were there several investments? Or what drove that increase in the quarter?

There was one investment that drove that. We don't give detail on that, but there was one investment that moved in that category 4.

And at this time, it looks like we have no further questions from the audience. I'd like to turn the floor back to Mr. Zugay for any additional or closing remarks.

Thank you, everybody, for participating. Thanks for the questions, and we'll talk to you next quarter.

All right. Ladies and gentlemen, that does conclude today's conference. We appreciate your participation. You may now disconnect.