Oaktree Specialty Lending Corp (OCSL) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2014 Fifth Street Finance Corporation Earnings Conference Call. My name is Ben, and I will be your operator for today. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

And now I would like to turn the call over to Mr. Dean Choksi, Executive Director of Finance and Head of Investor Relations. Please proceed, Sir.

Thank you, Ben. Good morning, and welcome to Fifth Street Finance Corp's Fiscal Third-Quarter 2014 Earnings Call. I'm joined this morning by Leonard Tannenbaum, Chief Executive Officer; Bernard Berman, President; and Richard Petrocelli, Chief Financial Officer.

Before we begin, I would like to note that this call is being recorded. Replay information is included in our July 15, 2014 press release, and is listed on the Investor Relations section of Fifth Street Finance Corp's website, which can be found at fsc.fifthstreetfinance.com. Please note that this call is the property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

Today's call may include forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and objections. We do not undertake to update our forward-looking statements, unless required by law. To obtain copies of our latest SEC filings, please visit our website or call Investor Relations at 203-681-3722.

The format for today's call is as follows -- Len will provide an overview of our results and outlook; Rich will summarize the financials and provide an update on our capital structure; and I will provide high-level commentary related to the BDC sector. Then we will open the lines for Q&A.

I will now turn the call over to our Chief Executive Officer, Len Tannenbaum.

Thank you, Dean, and welcome, everyone, to our 25th FSC conference call -- quarterly conference call.

Before we begin, I would like to introduce our investors and analysts to Richard Petrocelli, our new Chief Financial Officer. Rich was previously our Chief Accounting Officer and one of the senior members of Fifth Street Finance and accounting team. He has over 20 years of finance and accounting experience in the asset management industry, including serving as the CFO of a smaller, publicly-trade BDC. We look forward to introducing Rich to our analysts and investors in the coming months.

Rich will continue reporting to Alex Frank, who remains in his existing role as Chief Operating Officer and a Management Committee member.

We are pleased to report June quarterly results of $0.25 per share of net investment income, which covered the dividends for the June quarter of $0.25 per share. This is the third quarter in a row where our net investment income per share has met our dividend.

The end of the June quarter, operating at a leverage ratio slightly above the high end of our target range of 0.6 to 0.8 times debt-to-equity, excluding SBIC debentures, we were comfortable operating at this level because we anticipated the repayment of our largest loan, Desert NDT, in early July.

Including our recent equity raise and repayments and originations to date, we're currently operating at a leverage ratio slightly below the low end of our target range. While our leverage ratio may fluctuate around the timing of deal fundings, anticipated repayments, and of course equity raises, we are committed to maintaining leverage over time at a range of 0.6 to 0.8 times debt-to-equity, excluding SBIC debentures.

In early July, our Board of Directors declared a 10% increase in our monthly dividend from 8.33 cents to 9.17 cents per share, beginning in September 2014. The new dividend represents $1.10 annualized run rate and over an 11% yield on the current stock price.

The Board's confidence and our improved earnings power is primarily due to funding investment in Senior Loan Fund Joint Venture 1, or SLF JV 1, which should lead to growth in investment income. We are working on ramping and expanding this JV and forming similar partnerships, because we have ample capacity relative to the 30% regulatory cap on non-qualifying assets.

The joint venture represents an efficient way to finance assets that enhance returns for our shareholders. It accomplishes many of the same goals as back levering, but it is a more efficient way to do the sell, since we can finance assets as a portfolio rather than on a transaction-by-transaction basis.

In July, the JV funded approximately $171 million out of its anticipated $300 million investment capacity in a diversified portfolio of senior assets. We are utilizing leverage as we fund the JV, and are currently generating a mid-teens return on our investment. We anticipate ramping and expanding the joint venture by this calendar year end.

We are confident in the outlook for potential future earnings growth later in the calendar year, based on solid performance in our primarily senior secured portfolio. We look forward to providing updates as we make further progress on our multiple initiatives to improve net investment income, including growing SLF JV 1, and potentially other similar entities.

Many of these initiatives would not be possible without the significant investment we have made in the overall Fifth Street platform and the size of Fifth Street Finance Corp's balance sheet. Future success in these areas should further differentiate us from our peers.

I will now turn the call over to our Chief Financial Officer, Rich Petrocelli, to discuss our financials in more detail.

Thank you, Len. I'm glad to be part of the Fifth Street team, and excited to have the support of the Board and other members of Management as Chief Financial Officer.

Fifth Street is one of only a handful of leading middle market sponsor-financed platforms. Through our relationships with select private equity sponsors, we have been able to source, underwrite, and structure a diverse portfolio of high-quality, primarily senior secured loans with a low amount of PIK income.

Our balance sheet is financed by multiple sources of debt funding, including a syndicated credit facility maturing in 2018, multiple sources of unsecured debt with staggered maturities, and two SBIC licenses. We believe both the right and left side of our balance sheet are well positioned to weather potential volatility in the capital markets.

We enter our third quarter of fiscal 2014 with total assets of $2.7 billion, essentially flat with the previous quarter.

Portfolio investments were $2.6 billion at fair value, and we had cash available on hand of $74.7 million. Net asset value per share was $9.71 at quarter end.

For the three months ended June 30, 2014, total investment income was $74.3 million. Net investment income increased to $34.7 million for the quarter, a 14% increase when compared to $30.4 million in the same quarter the previous year.

During the quarter, we received $176.7 million in connection with the full repayments of five of our debt investments, all of which were exited at or above par, and that price is consistent with our fair value marks. We received an additional $48.3 million in connection with syndications of debt investments to other investors and sales of debt investments in the open market.

The credit quality of the portfolio remains strong, with the exception of one security previously categorized as an investment ranking 3, which accounted for approximately two thirds of the overall portfolio net unrealized loss of $13.7 million. This investment has a remaining fair value of approximately $6.2 million, or just 0.2% of the total portfolio. The balance of the net unrealized loss for the quarter was due to an increase in credit spreads in the middle market, which impacted the fair values across the portfolio.

The weighted average yield on our debt investments was stable quarter over quarter at 10.8% with the cash component of the yield making up 9.8%. The average high for the debt -- portfolio of debt investment was $24.4 million at June 30, 2014.

We had gross originations of $177.3 million in seven new and five existing portfolio companies, bringing the total companies in our portfolio to 125 at quarter end.

We believe we are conservatively positioned relative to our peers with over 94% of the portfolio by fair value consisting of debt investments, 82% of the portfolio invested in senior secured loans, 72% of the debt portfolio consisting of floating rate securities, and no CLO equity at quarter end. The investment portfolio continues to be very well diversified by industry, sponsor, and individual company.

Our largest single industry exposure remains healthcare, including pharmaceuticals, at 22% of the total portfolio. Our investment in HFG, our healthcare finance portfolio company, was our second largest single exposure at only 4.6% of total assets. And HFG itself holds a diversified portfolio of asset-backed receivables.

Our top 10 portfolio company investments represent 29.9% of total assets.

The credit profile of the investment portfolio continues to be strong at 99.8% of the portfolio. At fair value, it was ranked in the highest 1 and 2 categories.

During the quarter ended June 30, 2014, we had one investment in the portfolio in which we had stopped accruing income.

As Len mentioned, we funded our first Senior Loan Fund Joint Venture in July. Concurrent with the funding, the JV closed on a $200.0 million credit facility provided by Deutsche Bank. By the end of the July, the JV drew $104.7 million on the facility to fund a diversified portfolio of senior secured loans totaling $171 million. We believe there is potential capacity to increase the size of the Deutsche Bank credit facility if we and our partner decide to increase our commitments to the JV. This JV, and other potential JVs, represent an important component of our future earnings.

In July, our Board of Directors declared monthly dividends of $9.17 per share, reflecting an annualized run rate of $1.10 per share, a 10% increase from our previous rate of $1.00 per share.

I will now turn it back over to Dean.

Thank you, Rich. Today I will talk about our venture lending unit, which is commemorating its one-year anniversary with the Fifth Street platform. Since the team joined last August, Fifth Street Technology Partners has closed seven transactions totaling over $100 million. The majority of those transactions closed within the last six months, after the initial startup days, and the team has an active pipeline of new investments.

FSC expanded into venture lending because the risk-reward of well-constructed transactions is attractive, and venture lending is not typically correlated to the overall middle market M&A cycle.

Venture loans are made to high-growth private companies with significant venture capital investment. They are generally senior in a company's capital structure, with higher average yields than our current portfolio's weighted average yield on debt investments.

Additionally, all but one of our current venture loans include warrants, which may be accretive to net invest -- net asset value per share, and generate future capital gains if these companies are acquired or complete an initial public offering.

Our venture lending team focuses on more mature, mid to late stage venture capital-backed companies. These expansion stage companies have existing customers and revenue, but may not be profitable since they are still investing in their business to support growth. Since later stage companies have revenue-generating customers, product development risk is somewhat mitigated, making this a safer investment for a lender.

As these companies continue to grow to a point where they may consider a sale or public stock offering, adding ventured debt to their capital structure helps to create value by providing capital to fund their business with minimal dilution to current equity investors.

Combining an established venture lending team that has deep sponsor relationships with the Fifth Street platform creates several advantages versus traditional venture debt lenders. Because we are a permanent capital vehicle with access to multiple funding sources, we are able to offer flexible sources of capital to support future growth or fund a tuck-in acquisition. This flexibility is an advantage versus certain private venture debt funds.

We also have a cost of funding advantage versus other non-bank lenders in the sector because we can utilize secured leverage, as well as access the unsecured debt markets at favorable rates because we are rated investment grade.

There are a handful of banks who are active lenders to venture capital-backed companies. We have begun partnering with some of them to help finance transactions. Once an intercreditor agreement is negotiated with the bank, we are generally in a better position to support the sponsor, as well as share future deal flow with the bank as their partner.

We are excited about having established a strong foundation for our venture lending platform in its first year, and look forward to discussing additional venture lending successes in the future.

Thank you for joining us on today's call. Ben, please open the line to questions.

(Operator Instructions) Troy Ward, KBW.

This is actually Ryan Lynch on for Troy. My first question, the SLF invested about $170 million post quarter end. Some of those investments were purchased from Fifth Street. Is that something you guys expect to continue to do, purchasing investments from Fifth Street's portfolio? And also, on a quarterly basis, what should we kind of be expecting for net investment growth in the SLF?

So the initial portfolio, we could do that because Kemper has been a partner of Fifth Street's for a very long time, and a syndicate partner as well. So they're very familiar with our assets and asset types. We don't expect to do that in this portfolio. We expect to actually originate new assets into it, and it's already grown from the level that we've reported so far.

We expect to finish the $300 million capacity easily by the end of this year, calendar year. But we also, as we said in our comments, I think, expect to expand this facility.

And then can you provide some additional color, maybe what was the cause of the new investment that went onto PIK non-accrual?

This is a wonderful, age-old legacy investment that's just the gift that keeps on giving. The investment was done with a private equity sponsor that we did no additional loans to in the past two or three years. It is very disappointing. We thought it could turn around. It doesn't. We had it in category 3. We pointed it out last quarter. We wrote it down significantly last quarter. We wrote it down further this quarter. It's now very, very tiny part of our portfolio. We expect in the next, whatever, two to five months that this will resolve itself in one manner or another. But it's 0.2% of our total portfolio.

Got it. And then my last question, there have been some outflows in the leverage loan funds. On calendar Q3, we've also seen widening out of single B bonds. Now those are obviously more in the liquid market, but are you seeing any of those trends of widening out yields trickling down to the middle market at all?

We are. [Bonds] have definitely traded off. Upper middle market loans have traded off, besides FSC, which is Fifth Street Finance Corp's, which is this call. We also have another public entity, as you know, FSFR. We also have other senior loan funds of the asset manager. Also, there's other senior loan funds. So we have a very good sense of the upper middle market as well, and we have seen widening spreads.

We think it will trickle down. It is trickling down to the middle market, and so that's good. A little bit of volatility and less money-chasing deals is a good thing for us.

Great. That's all for me, guys.

Christopher Nolan, MLV & Company.

The non-accrual again, in the Q it mentions that the PIK income is non-accrual, but in the list of investments it shows it's mostly a cash coupon. Is the investment changed over to all PIK, or is it just a wording issue?

Page 15 of the Q?

Yeah, I'm just looking at the Q on this. And in the list of investments, it's --

It's mostly PIK at this point. I believe there is a small portion of cash.

Okay. So subsequent to the Q it was converted from mostly cash to mostly PIK, correct?

You can see on page 15 of the Q, you can see the adjustments.

Got it.

But as opposed to some public BDCs that do this, we put this on PIK, non-accrual. So we are not accruing the PIK.

No, I got that, Len. Just trying to get a clarification. And also follow-up question. Into the joint venture, $51 million in equity from FSC was invested. If you lever up the facility up to the $300 million, would that $51 million be sufficient to cover that incremental investment, or would you anticipate making --?

We would increase our -- our investment will increase to $87.5 million. Total equity will be 100 -- $12.5 million from Kemper with $200 million of leverage from Deutsche Bank.

Okay, that's it. And Rich, congrats on the promotion.

Thank you very much, Chris.

Robert Dodd, Raymond James.

Just a question about capital allocation between the SLF and on balance sheet, et cetera. And the equity. So obviously you raised money in July after knowing that Desert was going to be paid. Desert obviously was enough from that repayment alone to fully fund the SLF up to the 87.5.

If I just look at the numbers, at a mid-teens return on the investment, even when fully deployed, that return from the SLF, the gross number is going to be less than $15 million, which is under the amount of the incremental dividend you have to pay out as a result of the equity raise. That's not including the fact that Desert obviously could have funded it.

So can you walk us through the logic of taking up the dividend, given you knew you had a big repayment, and the SLF investment alone isn't enough to cover the incremental dividend of the shares raised?

I think there's a lot of confusion in the statement you just made. And to go through it now is a very long time. So we're happy to go through it, however, the reason we did an equity raise is pretty simple.

We entered the quarter slightly above the high end of our target range, which I really don't remember being in. The reason we were so highly levered is because we knew Desert NDT would repay. When Desert NDT repaid, which happened very quickly after the end of the quarter, because we were noticed by these private equity firms. Our private equity firms are our partners. 95% of our deals come from private equity. So we have some good visibility into repayments and when we expect repayments.

When the leverage drops back into the target range, very soon after the quarter, they're still in the target range. So it's still levered all the way through. The equity raise did not, as opposed to past equity raises which took us substantially below the bottom end of the target range, this took us slightly below the bottom end of the target range, and it is necessary going into the final quarter of the year.

As I've said repeatedly, our busiest quarter is calendar fourth quarter. And we are a 95% private equity sponsor business. We will have money for our private equity sponsors when they need it in regards to the busiest quarter of the year.

And fortunately, since we accomplished the equity raise, and are able to fund the SLF, and we believe we can expand it, we have capacity to satisfy our sponsor relationships through this year.

Okay. I appreciate that. Thank you.

That is currently all the questions that we have at this time. I would now like to turn the call back over to Dean for closing remarks.

Thank you for joining today's call. Have a good day.

Thank you very much. Ladies and gentlemen, that concludes the presentation. You may now disconnect. Have a good day.