Logan Ridge Finance Corp (LRFC) 2020 Q2 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 ended June 30, 2020. (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 host for today's call are Capitala Finance Corp.'s Chairman and Chief Executive Officer, Joe Alala; and Chief Financial Officer and Chief Operating Officer, Steve Arnall.

Capitala Finance Corp. issued a press release on August 4, 2020, with details of the company's quarterly financial and operating results. A copy of the press release is available on the company's 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 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 section 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, and thank all of you for joining us today. During the second quarter, we monetized over [$10 million] of assets to cash, improving [NAV] and materially reducing portfolio exposure to COVID-sensitive companies. We currently have approximately $95 million cash focused on leveraging the balance sheet. Net asset value at June 30, 2020, was $6.46 per share, up from $6.27 per share at March 31, 2020. The increase was the result of appreciation in our investment portfolio.

At June 30, we had $95.2 million of cash. During the second quarter, we received $51.1 million of repayments, resulting from the wind down of Capitala Senior Loan Fund II and a number of repayments, including the repayment of investments held in COVID-sensitive and consumer-facing businesses. As a result, the company is in a great position to reduce leverage through the repayment of SBA debt maturities and the prepayment and/or buyback of other debts outstanding.

At quarter-end, we had 5 debt investments on nonaccrual status, down from 8 at the prior quarter-end. Our portfolio management team will continue to work with all of our portfolio of companies, management teams and sponsors, where appropriate, in an effort to reduce the level of nonperforming investments. Distributions remain suspended for third quarter of 2020. We understand the need to rebuild net investment income in support of future distributions and are focused on that end. Continued progress on reducing nonaccrual loans and the closing of new investments during the second half of 2020 will help in this regard.

Looking ahead, we are in a good position from a liquidity standpoint both at Capital Finance Corp. and across our entire platform. Our direct origination platform and underwriting team is in various stages of review investment opportunities in the lower middle market. Our commitment to lower total and regulatory leverage should provide future growth and net investment income and ultimately resumption of quarterly distributions. As a platform, we are currently pursuing approximately $100 million of new investments to be completed in the next few weeks. As a platform, we continue to have an active pipeline of over $700 million of active small business investment opportunities.

At this point, I would like to ask Steve to provide some comments on our second quarter results.

Thanks, Joe. Good morning, everyone. Total investment income was $7 million during the second quarter of 2020, $4.6 million lower than the second quarter of 2019. Interest and fee income declined by $4 million, resulting from a decline in average debt investments outstanding and the impact of nonaccrual investments, which approximated $0.09 per share for the current quarter.

Dividend income decreased by $0.4 million due to the wind down of Capitala Senior Loan Fund II during the second quarter of 2020. Total expenses were $7.6 million for the second quarter of 2020 and 2019. During the second quarter of 2020, the company recorded $1.1 million in deferred financing charges related to the early termination of its senior secured credit facility.

Net realized losses totaled $13.3 million for the second quarter of 2020 compared to net realized losses of $15.1 million for the same period in 2019. Net realized losses during the second quarter of 2020 did not have a material impact to NAV per share, as realized amounts were generally in line with the previously reported fair values. Net unrealized depreciation totaled $17.0 million or $1.04 per share for the second quarter of 2020 compared to net unrealized depreciation of $17.4 million for the comparable period in 2019.

Net assets at June 30, 2020, totaled $105.1 million or $6.46 per share compared to $9.14 per share at December 31, 2019. At June 30, 2020, we had $95.2 million in cash and cash equivalents. Also, as of June 20 -- June 30, 2020, our asset coverage ratio was 182.7%. If our asset ratio -- coverage ratio falls below 150% due to a decline in the fair value of our portfolio, including the result of the economic impact of COVID-19, we may be limited in our ability to raise additional debt. During the second quarter of 2020, the company terminated its senior secured credit facility. It is our intent to replace this line during the second half of 2020, though it's premature to provide details at this time.

In addition, on July 30, 2020, our Board approved a bond repurchase program under which the company may repurchase up to an aggregate of $10 million worth of the company's outstanding 5.75% convertible notes due in 2020 and/or its 6% notes due in 2022. The company will repay $19 million of SBA debentures maturing on September 1, 2020, and is evaluating the prepayment of all or a portion of the $46 million that mature in March 1, 2021.

At June 30, 2020, our investment portfolio included 37 investments, with a fair value of $287.3 million and a cost basis of $305 million. First lien debt investments on a fair value basis at June 30, 2020, comprised 67.4% of the portfolio, second lien represents 13.3% and equity warrant investments represent 19.3%. At June 30, 2020, we had 5 debt investments on nonaccrual status, totaling $23.9 million on a fair value basis compared to $42.9 million at March 31, 2020. As Joe mentioned, we're in various stages of review on a number of investment opportunities and our pipeline is active.

At this point, we would like to turn it over for questions.

(Operator Instructions) Your first question comes from the line of Kyle Joseph with Jefferies.

First question, it's great you showed up your liquidity in the quarter. But just really wanted to hone in on your capital allocation priorities. You talked about the debt pay down, servicing existing borrowers and then as well as adding new investments. Is there any rank to those priorities? Or is it really more of a blend of those 3?

Kyle, this is Steve. I would say it's a blend of all 3, the way you phrased that. Certainly, we want to make sure our existing portfolio has the liquidity that it needs to make it through this cycle. Certainly, delevering the balance sheet is a high priority. And then thirdly, certainly, we'd love to evaluate some new investment opportunities as we have the liquidity available to do so. So a blend of all 3.

Got it. That makes sense. And then yes, your repayments were elevated in the quarter. Can you give us a sense for the outlook there? Would you expect more -- I saw what you guys have done quarter-to-date. But going forward, any big maturities coming up that you're looking to term out? Or what's your outlook for repayments going forward?

As far as repayments, nothing -- this is Joe. Nothing out of the ordinary. I do think last quarter, we were actively managing those repayments. We wanted to reduce exposure in sort of consumer-facing industries, which we did materially. We wanted to unwind the Senior Loan Fund II, which, as part of our deleveraging, also created liquidity. So we intentionally sought repayments to create liquidity last quarter. So a lot of that was not just passive repayments, it's active management in creating those repayments, and we did it by improving NAV. We think that was a -- it's easy to sell things below your mark. But when you're getting your mark for those on an average basis, improving NAV, we think that was very good.

And we continue to maintain a very active pipeline of opportunities. As I mentioned, the platform in our private funds, we're closing about $100 million of deals in the next few weeks. The pipeline is over $700 million. The BDC, once it begins reinvesting, has an active pipeline, and it can start right away. We continue to balance the wind down of a legacy SBIC Fund. We do have a green light that we received in May of this year to pursue a new SBIC Fund. So we're sort of managing all this liquidity with those things in mind, too.

Understood. And then last one for me, and I can hop back in the queue. But there's been some moving parts in terms of the portfolio recently in yields. We have the rate environment, some NPA fluctuations and then theoretically wider spreads in the market today. Can you give us a sense for your outlook for the yield going forward of the overall portfolio?

Kyle, you were breaking up a little bit at our end. Could you ask that again? I'm sorry.

Sure. I was just talking about your outlook for the yield on the portfolio going forward, balancing some movements in NPAs, the rate environment, LIBOR floors and all of those factors and how you see -- and then theoretically wider spreads on new deals.

Yes. This is Joe again. The current deals pending on the credit side, yields are double digits that are first lien in nature, where (inaudible). The loan to values are materially lower than pre-COVID. So it's a nice set of assets. We continue to pursue and close in our private funds. And when the BDC is ready to participate, it will plug right into those opportunities. But it's a good time to be providing investments to small businesses in the right industries. And we're in a unique position that we have 7 offices. We're able to visit companies and participate in on-site diligence meetings. We're primarily doing that by driving to opportunities versus flying. And that's something unique about our origination platform is that we have these 7 offices throughout the country. And we're visiting companies and completing diligence on these deals and getting them closed.

Got it. Congrats on a nice recovery in the quarter.

Thanks, Kyle. Appreciate it.

Your next question comes from the line of Christopher Nolan with Ladenburg Thalmann.

Steve, can you tell me what the drivers of the realized losses were, please?

Certainly. Really related to 2 items, if you'll note in there. One was related to investment in ABS, where we really converted the debt to equity. So it's kind of a change in our structure. And the other one was related to our investment in Sur La Table, where we sold our position in the company to a third party.

Okay. And neither one of those were nonaccrual last quarter?

Yes. I think both of them were.

Great. Your comments on the debt repayment priorities, if I heard you correct, the SBIC has the maturities in early 2021. So that would be the priority of the business first?

We've got 2 maturities, one in September 1 this year and the other one is March 1 of next year, $19 million and $46 million, respectively. And so clearly, those are priority. We're going to repay the $19 million and some portion or all of the maturity from March as well. So we just haven't determined the amount yet, but yes.

Got you. And I guess, specific on [the second half of the year], should we expect cash holdings to increase as BDC collects repayments and sort of waits for good investment opportunities? Or should we see that perhaps holding balance go down?

Can you ask it one more time? You broke up just a little bit, I'm sorry.

Sure. Is the plan to hold off on your investments in the second half of the year? Or is it to make new investments? From what Joe said, it seems like you guys are going to be making investments in the second half of the year.

Yes. Chris, this is Joe. I think the second half of the year, we will make new investments. The platform continues to be active in completing new investments. We would like to get as many of these new investments into a new SBIC, so we could leverage that at a very attractive, low-cost, long-term leverage that the SBIC program provides. And that's -- we do have substantial liquidity, and we're balancing the deleveraging, the funding of a new SBIC, the repurchase of bonds in the support of our existing portfolio of companies. So it's a balance that we're evaluating on a daily, weekly basis. But as soon as the BDC is ready to participate in new deals, the pipeline is active and it just needs to begin participating on its pro rata basis.

Got you. And Joe, when do you expect new SBIC license to be active?

That's -- it's very hard to predict the SBIC time line. We received the green light in early May of this year. We need to enter the final stages hopefully sooner rather than later. And if I knew that time line, I can answer sort of when do we begin new investing actively better. But that is a time line that we do not set that it's set by the SBIC, the licensing process, but we hope sooner than later.

And at this time, there are no further questions. We do have a question from the line of [Robert Dang] with Hillside Capital.

This is [Robert] from Hillside Capital. I have 2 questions. One is that on your presentation, you say that the obligor for the SBA debenture is the subsidiary -- SBIC subsidiary. Now you also disclosed that the total assets of the subsidiary was about $238 million. Could you clarify out of that asset how much is cash and how much is loan?

Yes. This is Steve. So as it relates to the SBIC sub that you're referring to, we've got a number of assets in there. We've got cash, and it's very fluid as we make payments. And that's, I would say, of the $230 million, $60 million in cash roughly with the rest being investments.

You say $6 million or $16 million?

$60 million, 6-0.

6-0. Okay. Great. Now my second question is that you -- most of your liabilities concentrate in early 2022, which is less than 2 years from now on. And looking at your portfolio, it seems that by that time, early 2022, you might not have enough debt mature by that time to pay down the huge balloon of debt. So any plan for the payments of the debt in early 2022, when all the notes and the remaining SBI -- SBA debenture mature?

Yes. This is Joe. Regarding debentures, the SBA that -- there's -- as you just mentioned, there's more assets in there than liabilities. At the BDC parent, there's more assets than liabilities. We're going to -- we've approved a $10 million bond repurchase, so we can buy some of those on the open market or redeem them and just retire them. We also know that the refinance market is active again. There was a similar lower middle market-focused BDC that did a bond raise in the past several weeks. So those markets are open again. We think they'll definitely be open longer periods of time over the next year, 1.5 years. So we will probably do a mixture of repay and refinance.

Okay. Just to follow up a little bit on this. I mean I apparently think that the -- both your equity and your notes and the convertible notes are way undervalued. But I do -- so you say that you plan to rely on both the payments from your existing portfolio of companies and the refinancing to pay down the debt that will mature in 2022. But given the valuation of both your equity and the notes, do you still believe that it's a good idea to rely on the refinancing of the debt to pay down the debt?

Well, I think that's part of the -- we will use cash and monetize some. Well, you can refinance some, the markets are open for that. You can also get some asset-based facilities to refinance portions of those. There are several options with those assets since the assets are greater than the liabilities over the next period of -- until maturity date that we can refinance those.

And there are no further questions at this time.

Thank you, everyone, for participating in the call. Steve and I and Kevin are around all day today if you would like to contact us. We look forward to next quarter's call. Thank you.

This concludes today's conference. You may now disconnect.