Logan Ridge Finance Corp (LRFC) 2017 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the Capitala Finance Corp.'s conference call for the quarter ending September 30, 2017. (Operator Instructions) Today's call is being recorded and a replay will be available approximately 3 hours after the conclusion of the call on the company's website at www.capitalagroup.com under the Investor Relations section.

The hosts for today's call are Capitala Finance Corp.'s Chairman and Chief Executive Officer, Joe Alala; Chief Operating Officer, Treasurer and Secretary, Jack McGlinn; and Chief Financial Officer, Steve Arnall. Capitala Finance Corp. issued a press release on November 6, 2017, with details of the company's quarterly financial and operating results. A copy of the press release is available on the company's website. In addition, the company posted a prerecorded podcast of its quarterly results November 6, 2017, on its website. Please note that this call contains forward-looking statements that provide information other than historical information, including statements regarding the company's goals, beliefs, strategies, future operating results and cash flows. Although the company believes that these statements are reasonable, actual results could differ materially from those projected in the forward-looking statements. These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the sections titled Risk Factors and Forward-Looking Statements in the company's quarterly report on Form 10-Q. Capitala undertakes no obligation to update or revise any forward-looking statements.

At this time, I would like to turn the meeting over to Joe Alala.

Thank you, operator. Good morning, everyone. Thank you for joining us, I'm actually dialing in from Berlin, Germany. But I have Steve and Jack that are in Charlotte in case something happens to my line here. In our second quarter earnings call, we outlined the priorities of the management and our Board of Directors. Those priorities are: Improve net asset value per share, generate a net investment income that will exceed our quarterly distributions; reduce the level of nonperforming investments; monetize equity positions; rotate into yield; grow earnings; invest in first lien unitranche opportunities in the lower middle market to capture better risk-adjusted returns.

Yesterday, we released our results for the third quarter of 2017. I would like to take a moment to provide you an update on our progress towards these aforementioned goals.

Net asset value per share declined by approximately 5% mostly related to unrealized depreciation for one of our nonperforming investments. Net investment income for the third quarter was $0.28 per share. On October 2, we announced our fourth quarter 2017 distribution of $0.25 per share. We fully understand the need to consistently cover distributions of net investment income. The reduction in our fourth quarter distribution, as noted in our announcement, accounts for a shift in our investment strategy to more senior secured and unitranche loans with lower yield and lower risk and less unsecured and mezzanine loans with higher yield and higher risk. We reduced nonaccural loans during the period through the restructuring of 2 investments; Sierra Hamilton and Kelle's Transport Services. We anticipate additional reductions in nonaccural balances over the coming quarters.

During the quarter, we received a $1.5 million distribution from our equity warrants in B&W Quality Growers, generating a realized gain of $1.5 million. We continue to pursue additional equity exits in an effort to rotate the proceeds into debt securities thus increasing BDC earnings.

During the quarter, we invested $7.1 million in the first lien debt and $1 million in the equity of CIS Secure Computing Inc. We have significant liquidity and dry powder to be active investors in the lower middle market. Our pipeline remains robust, however, we are being disciplined from an underwriting standpoint as we may be approaching the later stages of a credit cycle. I would like to point out that since the second quarter of 2016, 78% of all of debt dollars invested were first lien structures, validating the change in the investment focus of the firm.

And with that, operator, we will open up the line for questions.

(Operator Instructions) Our first question is from the line of Ryan Lynch of KBW.

The first one, you mentioned significant liquidity and dry powder to continue to invest in the middle market. When I look at your leverage ratio. You guys have a total debt-to-equity of about 1.28x and a regulatory debt-to-equity, which is, what really, kind of, governs your growth of 0.54x. So I just wanted to know where do you see these leverage ratios going? Are you guys comfortable with taking total -- forgetting about regulatory leverage for a minute, but the total debt-to-equity of 1.28x, are you guys comfortable with taking this number significantly higher?

Ryan, this is Steve. I think, as you just look at the global picture of liquidity and dry powder. First, we've got $50 million at the end of the quarter. The majority of that being in the SBIC subs and we certainly expect to utilize those dollars to be active investing in debt-to-equity in securities. And as noted, our senior secured lien was paid to $0, at the end of September, gives us $114 million available. But to your point, we certainly would never anticipate drawing all of that from a leverage standpoint. As we look at regulatory leverage of 0.5x, we've, kind of, talked about previous quarters and years that we would not want to be pushing that regulatory ratio up anywhere north of 0.8x, so somewhere in the 0.75x range is probably an optimal level from a performance standpoint. As far, where that takes the total leverage ratio. Yes, we'd be comfortable moving that up a little, but not to the point where the regulatory ratio would go above, say, 0.75x.

Okay, that's helpful. And then, as I look at your portfolio, you guys have discussed moving up the capital structure, which should create some safer results in the future, hopefully, less losses, but part of that you have to give up is yield. And if I look at you guys current portfolio yield, debt investment yield on page 16 of your slide deck, it's about 12.9%. If I look at Page 6 of your slide deck, you guys have your year-to-date originations. Those have a yield of about 10.5%. So new originations in 2017 are about 200 basis points lower than your current portfolio yields show. Should we continue to expect your overall portfolio yield of 12.9% to basically merge and trend lower to that 10.5%, 11-ish percent mark going forward?

Ryan, this is Joe. We have done a very good job, I believe, of moving our strategy since second quarter of 2016. We have lowered some of the yields, but you also need to look at the Q4 yield of '16, a lot of those were in first lien unitranche, they were materially higher than 10%, but I do think with this strategy, we will probably lose 150 to 250 basis points on yield, but we'll be in a much better structure and we'll have much better covenants and controls over those credits. So we will sacrifice yield to be in the better structure and we've been doing that since Q2 2016. If you look on the deals we have done since Q2 2016, we're not having any kind of credit weaknesses in those deals. Very good structures, underlying credits are performing very well.

And yes, I definitely agree, it is always better to give up yield and not stretch on credit. I mean, ultimately, I think that generates better long-term result, even if it's sacrificing yield today and saving credit loss in the future. You mentioned part of your strategy is to monetize some equity investments. I mean, you guys have a very large portion of your portfolio today in equity investments, some in warrants, some in just some pure equity co-investments. What is your ability to actually exit some of these equity investments versus you guys, basically, having to wait along and hope that these companies are sold and that will allow you to, kind of, exit, basically what -- is there a large percentage of your equity portfolio today that you guys can be proactive and actually exit out of it and sell off?

Yes, this is Joe again. On the global comment, most of these positions are not controlled positions. So it's very hard for us just to monetize those on a unilateral decision. Having said that, we are constantly searching for ways to try to monetize these positions. The good news is that equity -- I think, it's around 22%, the cost base is about half of that. So these are appreciated equity positions. And -- but we are constantly looking at ways to monetize those either selling back to the company, selling to a third party with the company's consent, maybe selling a strip of them, we're constantly looking at those, try to monetize those because that will really enhance our earnings going forward. But to just unilaterally make a decision to sell those, we are not in that position amongst all of those deals, but we are actively seeking for exits for those equity positions.

(Operator Instructions) Our next question is from Christopher Nolan of Ladenburg Thalmann.

On Velum Global Credit Management, it shows at the end of December, it's a 15% PIK. Any issues with that credit? And should we expect, because it's a pretty large jump in cash balances when it matures?

Chris, we have trouble hearing you. Can you repeat that? It was garbled.

Yes. Velum Global Credit, it's 15% PIK, it matures at the end of the year, should we expect a big jump in cash balances because of the PIK investment when it matures?

Yes. I mean, we're actively in conversations with them about, whether we need to extend that or not. So that's playing out, as we speak.

Okay. And then the reason to -- reason for the extension would be?

Just the nature of the investment and the underlying assets there need more time.

Okay. And then second question, the tax provision, that's $2.6 million, that generate a deferred tax liability of $2.6 million. Is it correct to say that if tax reform goes through that will be an impact to book value per share?

Potentially, that -- I think, that's premature to get to make that conclusion, but it's possible.

And I'm showing no further questions at this time. I'd like to turn the call back over to Joe Alala for any further remarks.

Thank you, everybody for participating in the call. We are around, especially Steve and Jack are in Charlotte all day, if you want to call and have some more direct conversation. Thank you and we look forward to the next earnings call.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone, have a great day.