Logan Ridge Finance Corp (LRFC) 2020 Q1 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 March 31, 2020. (Operator Instructions) Today's call is being recorded and will be available for replay 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 May 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 and other historical information, including statements regarding the company's goals, beliefs, strategies, future operating results and cash flows. Although the company's beliefs in 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, and thank you for joining us today. First, I hope you and your families are safe and healthy. The well-being of our team is of the utmost importance to us.

Having the technology platform to allow us to work from home has enabled our team to comply with all the stay-in-home pandemic policies without impacting our firm's ability to focus on our investment portfolio and operations.

Our net asset value declined by $2.87 per share during the quarter. Of this amount, $1.18 or 41.1% is related to unrealized depreciation on equity investments. We ended 2019 with no nonaccrual loans. We now have 8 debt investments on the nonaccrual status driven by the shutdown in the economy. Our seasoned team of portfolio management professionals is managing the status of all investments on a daily basis.

Based on uncertainty related to the future net investment income, we have decided to suspend our distributions effective for the second quarter of 2020. This was a difficult decision but ultimately, the right one until we can better project cash flows related to interest and principal payments from our portfolio investments. We are committed to retaining our status as a registered investment company and will make the necessary distributions to shareholders as required during 2020.

We are pleased to announce that the Small Business Administration has issued us a green light, allowing the application process to proceed for Capitala SBIC Fund VII, which will be a wholly owned subsidiary of Capitala Finance Corp. By lowering our cost of capital and accessing additional capital through the addition of another SBIC fund, we are able to generate additional net investment income in support of future distribution payments.

Looking ahead, we are in a good position from a liquidity standpoint, both at Capitala Finance Corp. and across our entire portfolio. When the economy reopens, we will be prepared to evaluate investment opportunities and make significant investments into new lower middle market opportunities originated by our direct origination platform.

At this point, I would like to ask Steve to provide some color on our first quarter financial results.

Thanks, Joe. Good morning, everyone. Total investment income was $7.1 million during the first quarter of 2020, $5.6 million lower than the first quarter of 2019. Interest fee and PIK collectively declined by $4.3 million driven by: first, a decrease in average debt investments outstanding during the comparable periods; and most importantly, two, $1.6 million of interest not earned during the first quarter of 2020 related to nonaccrual loans.

Dividend income decreased by $1.3 million as we received a $1.3 million dividend from our equity investment in Nth Degree during the first quarter of 2019. Total expenses for the first quarter of 2020 were $7.1 million compared to $8.5 million for the first quarter of 2019.

Interest and finance expenses declined by $0.6 million related to a reduction in debt outstanding. Base management fees declined by $0.4 million as total assets declined over the comparable periods.

Incentive fees declined by $1 million as incentive fees were not earned during the first quarter of 2020. And general and administrative expenses increased by $500,000, mainly related to timing of legal and other professional fees.

Net realized gains totaled $1 million or $0.06 per share for the first quarter of 2020 compared to net realized losses of $5.8 million or $0.36 a share for the same period in 2019. Net unrealized depreciation totaled $43.4 million or $2.68 per share for the first quarter of 2020 compared to net unrealized appreciation of $1.5 million for the comparable period in 2019. Approximately 44% of the net unrealized depreciation during the period related to equity investments.

The net decrease in net assets resulting from operations totaled $42.4 million or $2.62 a share for the first quarter of 2020 compared to a net decrease of $0.2 million for the comparable period in 2019. Net assets at March 31, 2020, totaled $102.0 million or $6.27 per share compared to $9.14 per share at December 31, 2019.

At March 31, 2020, we had $56.4 million in cash and cash equivalents. Also at March 31, 2020, the company was not in compliance with certain debt covenants in our credit facility, including its minimum net asset value covenant and its minimum interest coverage covenant.

The company's noncompliance with these covenants was largely driven by the increase in nonaccrual loans and an increase in the unrealized depreciation as the result of the impacts of COVID-19. The company will not be able to borrow under its line credit facility until a waiver or amendment can be attained from ING Capital LLC and the lender group or until such time that we -- they can comply with the existing debt covenants in the credit facility. It should be noted that the facility was undrawn at March 31, 2020.

Also as of March 31, 2020, our asset coverage ratio was 180.2%. If our asset coverage ratio falls below 150% due to a decline in the fair value of the portfolio, including the results of the economic impact of COVID-19, we may be limited in our ability to raise additional debt in the future.

At March 31, 2020, our investment portfolio includes 41 investments with a fair value of $321.2 million on a cost basis of $356.0 million. First-lien debt investments on a fair value basis at March 31, 2020, comprised 65.7% of the portfolio, second lien represents 16%, equity and warrant investments represent 14% and our investment in Capitala Senior Loan Fund represented 4.3%.

At quarter end, we had 8 debt investments on nonaccrual status totaling $42.9 million on a fair value basis compared to 0 at the previous year-end. The significant change in nonaccrual loans is mainly driven by current economic conditions resulting from COVID-19. As previously mentioned, our portfolio management group is actively engaged with management teams and sponsors as appropriate to assess needs and provide assistance as appropriate.

Regarding the valuation process. At quarter end, our Board approved the fair value of the investment portfolio of $321.2 million in good faith in accordance with the company's valuation procedures. The company's Board of Directors approved the fair value of the company's investment portfolio with input from a third-party valuation firm and the investment adviser based on information known or knowable at the valuation date, including trailing and forward-looking data. The COVID-19 pandemic is an unprecedented circumstance that materially impacted the fair value of the company's portfolio at March 31, 2020.

At this point, operator, we will entertain questions.

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

I hope everyone there is safe. I just wanted -- obviously, broader equity markets have recovered since 3/31, and it sounds like a lot of the unrealized depreciation in the first quarter was tied to equity investments. I just want to -- can you give us a sense for, at current levels, how much of NAV has recovered post 3/31?

Kyle, this is Steve. It's a good question. I think for us to try to quantify what those equity values would be subsequent to March 31 would be inappropriate. We'll go through a fulsome exercise internally and with our Board at June 30. But understand what you're asking and hope that, that momentum continues. But to try to quantify that for you would just be inappropriate at this time.

No, that's totally fair. Congratulations on the new SBIC. Can you just give us a reminder of the timing and the process for rolling that out?

Yes, Kyle. This is Joe. So we received a green light letter, which -- basically, it's an invitation to submit an application, which we have already submitted the application. So we are in process with the SBA on obtaining a subsequent license in the BDC. So we have filed the application and it goes into legal review now. And we think it's a this quarter event that we would be fully licensed.

All that is uncontrollable and part of the SBA control of all that. But -- and we are already preparing to -- we have to fund some of the SBIC to start the application process, which we've already done and committed to. And we think that will be a great new subsidiary that's going to get low-cost, attractive long-term debt capital with a 10-year at 65 basis points or around thereabout. It's very low-cost of capital for us plus increases our access to capital. So we're excited about the new SBIC license, and the application has already been submitted.

Got it. And then last question for me. Obviously, deal flows kind of dried up given all the volatility. But as we hopefully emerge on the other side of this, can you give us a sense for how you anticipate new transactions looking?

Well, I will say that what we focus on is, one, keeping the team healthy; and two, keeping the team together. So we had no turnover on our origination offices, no turnover in our core investment team, and we're going to keep that team intact. When deal flow does come back, we're able to start visiting companies again and investing in new opportunities. We have substantial liquidity.

Beside the BDC and our private funds and in addition to getting an SBIC license in our BDC, we actually got another SBIC green light in a private fund. So the platform is probably one of the more liquid, lower middle market platforms that we compete with and no change in investment teams. So when the market does turn, we have tremendous liquidity, same team and are ready to start investing in quality lower middle market companies again.

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

Hope everyone's well. Joe, what is the amount of -- for the new SBIC sub, what -- how much can that lend up to once it's fully capitalized?

The new family of funds limit is $175 million per fund, and that would apply to this new fund.

Okay. And then going forward, what is the balance sheet strategy given that your leverage ratio is going up? Your unrealized depreciation is increasing as well. I mean is it to stop doing investments, build cash, pay down debt, issue equity? I mean can you give us an idea of where your thinking is in terms of how you're going to manage the balance sheet and your capital ratios?

Kyle -- Chris, this is Steve. I think in the short term, what we're focusing on is the portfolio and trying to make sure that we're here to provide liquidity and support to our portfolio of companies. That's the nearer-term goal.

I think longer term, you touched on a number of topics that are of importance to us, timing to be determined in terms of potentially refinancing some of our baby bonds and pushing those maturities out, maybe repaying some additional SBA debentures early. We've got one coming up in September.

Raising some equity, that's a topic of discussion, but probably not right now. And certainly, with the liquidity that we have, not only at the BDC, but at the platform level, we fully expect to be active in the lower middle market and hopefully that the BDC can participate in those deals once those are active.

So short term, focus on the portfolio. Longer term, rebuild our portfolio in the BDC and try to continue to build NII and reassess that distribution level.

Great. And also, where are you looking to keep cash levels on the balance sheet given the absence of the credit facility?

I'm not sure how to answer that in terms of a number. I think we will continue through cash that we have now and repayments than normal cash flow. We are in a good position to not only service all of our obligations but repay all the debentures that are coming due. So internally, I think we feel pretty good about our liquidity position in that regard. But we'll see where circumstances go with the situation in the economy and to the extent it opens back up and we can do some -- get some deal flow going here.

Great. Final question, dividend. Given that -- it sounds from Joe's comments that the dividend will be probably just sufficient to keep the RIC status. Would that be a stock dividend?

Premature to discuss what any distribution might look like. I think we've suspended it for the second quarter until we, again, can get a better look at what NII looks like the rest of the year. We overdistributed for Q1. We'll talk with our Board and determine what's the right thing to do going forward, but that would be premature to talk about, the mix of any future distribution. So not just for sure, but not something that we're prepared to talk to.

Your next question comes from the line of [Bob Strong], a private investor.

At this time, sir, we have no further questions.

Thank you, everyone. We are around today if you want to contact us, and thank you for your participation. Everyone, keep safe and socially distant. Thank you.

This does conclude today's conference. You may now disconnect.