Oaktree Specialty Lending Corp (OCSL) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to Fifth Street Finance fourth-quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Robyn Friedman, Head of Investor Relations. Ma'am, you may begin.

Thank you, Kaylee. Good morning and welcome to Fifth Street Finance Corp.'s fourth-quarter and fiscal year-end 2016 earnings call. I am joined this morning by Bernard Berman, Chairman of the Board; Todd Owens, Chief Executive Officer; Ivelin Dimitrov, President and Chief Investment Officer; and Steven Noreika, Chief Financial Officer.

Before we begin, I would like to note that this call is being recorded. Replay information is included in our November 29, 2016 press release and is posted 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 conference call may include forward-looking statements and projections that reflect the Company's current views with respect to, among other things, future events and financial performance. Forward-looking statements may include statements as to the future operating results, dividends and business prospects of Fifth Street Finance Corp. Words such as believes, expects, seeks, plans, should, will, estimates, projects, anticipates, intend and future or similar expressions are intended to identify forward-looking statements, although not all forward-looking statements include these words.

These forward-looking statements are subject to the inherent risks and uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ materially from those projected or implied in these forward-looking statements. New risks and uncertainties arise over time and it is not possible for the Company to predict those events or how they may affect it. Therefore, you should not place undue reliance on these forward-looking statements.

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 projections. To obtain copies of our latest SEC filings, please visit our website or call investor relations at 203-681-3720. FSC undertakes no obligation to update or revise any forward-looking statement whether as a result of new information, future events or otherwise except as required by law.

The format for today's call is as follows. Bernie will provide introductory remarks. Todd will provide an overview of our results and Steve will summarize the financials. Then we will open the line for Q&A. I will now turn the call over to our Chairman, Bernie Berman.

Thank you, Robyn. Before turning to our results, I would like to take a moment to discuss the recent management changes that were announced this morning. The FSC Board of Directors has appointed Patrick Dalton as Chief Executive Officer and a member of the FSC Board of Directors effective January 2, 2017. Patrick will succeed Todd who will continue serving as CEO and a member of the Board of Directors through the end of the year to ensure a smooth transition.

Additionally, Ivelin will be stepping down as CIO and a member of the FSC Board of Directors also effective January 2, 2017. We are grateful to have had Todd serve as CEO and Ivelin serve as President and CIO of FSC. We would like to thank both of them for all of their hard work and the numerous contributions they made during their tenures.

Looking ahead, we are excited to have Patrick join FSC. Patrick will assume responsibility for all aspects of FSC's investment and operating strategies. We believe that the combination of his executive leadership experience and credit investment background make him an ideal choice to lead FSC through its next chapter. Patrick is an industry veteran with significant middle-market lending experience. Most recently, from September 2012 until March of 2016, including through its sales of Blackrock Capital Corporation, he worked at Gordon Brothers Finance Company where he served as President and CEO, as well as Chair of the Investment Committee. Gordon Brothers is a commercial finance company that provides cash flow, asset-backed and hybrid term loans to middle-market companies.

Prior to Gordon Brothers, Patrick was President and Chief Operating Officer at Apollo Investment Corporation, a publicly traded BDC, from 2008 until 2012; Chief Investment Officer and portfolio manager at Apollo Investment Management LP from 2007 until 2012 and was also a founding partner of Apollo Global Management in 2004. With his 25 years of investment experience, we are pleased that Patrick will take over responsibility for FSC's investment strategy with the ultimate goal of enhancing returns for our shareholders and stabilizing NAV. We look forward to introducing Patrick to our investors and analysts in the coming months.

Lastly, on our previous conference call, we announced our decision to evaluate ways to enhance the alignment of interests between our external advisor and our shareholders. Patrick, the entire FSC team and Board are all committed to making shareholder-friendly changes to our fee structure, including a total return hurdle and plan to finalize it in the new year.

Additionally, prior to the expiration of our previous stock repurchase program, our Board of Directors approved a new $12.5 million stock repurchase authorization. This allows us to complete the $50 million of share repurchases for calendar year 2016 that we previously announced in February. As always, we are committed to deploying capital in a manner that achieves the best possible returns for our stockholders and plan to revisit the size of the repurchase authorization in the new year.

I would now like to turn the call over to our CEO, Todd Owens, to provide an overview of the quarter's results.

Thank you, Bernie. I have enjoyed leading FSC over the past two years and I am proud of the steps we have taken during my tenure to put FSC on a more sustainable path. I am confident that Patrick has the right experience and industry knowledge to lead FSC into its next phase. I look forward to working with him in the coming weeks to ensure a seamless transition.

Now turning to our September quarter results. FSC generated $0.18 of net investment income per share covering our quarterly dividend. We are pleased that our net investment income has covered our dividend for the seventh consecutive quarter, excluding incremental professional fees incurred earlier this year.

During the September quarter, we repurchased $12.5 million worth of shares in the open market at an average purchase price of $6.08. These share repurchases were $0.03 accretive to NAV per share. Since the beginning of this year, we have repurchased a total of $37.6 million or 4.7% of FSC's outstanding shares, which ranks amongst the highest of our peers.

We ended the quarter with regulatory debt to equity of 0.83 times, above our targeted leverage range of 0.6 to 0.8 times. We felt comfortable ending the quarter at this level because we expect that originations, net of repayments in the December quarter, will bring leverage back within our targeted range.

Turning to the middle-market environment, the September quarter was marked by continued sluggishness mainly due to a lack of M&A deals by private equity firms coupled with global growth concerns. Given this backdrop, during the September quarter, we closed $123 million of investments in five new and five existing portfolio companies. We believe that in this competitive environment, Fifth Street's established relationships with private equity sponsors are increasingly important. As an incumbent lender, the Fifth Street platform has the ability to screen a broad market opportunity set and is well-positioned to choose select deals that we believe are mutually beneficial.

In our view, the overabundance of liquidity chasing too few deals remains an ongoing factor in our market as it has driven leverage levels higher and yields lower. In an environment such as this with large amounts of capital chasing fewer deals, we believe it is important to be disciplined and employ a high degree of selectivity. As a result, we have not seen many deals in our pipeline that we believe provide adequate risk-adjusted returns despite projected refinancings. We are content to avoid aggressive deals that are inadequately priced for risk as we are well into the current credit cycle and do not believe this is the environment for aggressive capital deployment.

At September 30, 2016, we had investments in 129 portfolio companies with 78% of our portfolio in senior secured loans. Additionally, at September 30, 81% of the debt portfolio consisted of floating rate securities. 67% of the total debt portfolio had a LIBOR floor between 1% and 2% with the majority of those loans having a LIBOR floor of 1%.

With three-month LIBOR gradually rising through the year, we have operated with increasing net interest margin pressure. When LIBOR exceeds 1%, that trend will reverse and FSC should experience improving net interest margins resulting in a benefit to earnings. This positive impact should increase as three-month LIBOR continues to rise since our liabilities have a mix of fixed and floating rate securities.

I would now like to turn the call over to our Chief Financial Officer, Steven Noreika, to discuss our financials in more detail.

Thank you, Todd. We ended the fourth quarter of fiscal 2016 with total assets of $2.4 billion as compared to $2.6 billion at September 30, 2015. Portfolio investments totaled $2.2 billion at fair value, which was spread across 129 companies at September 30, 2016. At the end of the September quarter, we had $130.4 million of cash and cash equivalents, including restricted cash on our balance sheet. Net asset value per share was $7.97 as of September 30, 2016 as compared to $8.15 in the prior quarter.NAV was impacted this quarter by a few factors, including credit-related losses, which were offset by accretion due to our share repurchases and market-driven writeups as spreads tightened in the September quarter.

Since last quarter, three investments rolled off nonaccrual status as we exited those businesses and three new investments have been added. At September 30, 2016, we had five investments on nonaccrual status, comprising 6.1% of our portfolio at fair value. We continue to work diligently with the private equity sponsors and management teams at our stressed investments on ways to improve the businesses and maximize recoveries for our shareholders.

We ended the September quarter at a 0.83 times regulatory debt to equity ratio, slightly above the upper end of our target range of 0.6 to 0.8 times. As Todd stated earlier, we have positioned our portfolio for a decrease in volume and expect to bring our leverage levels back within our targeted range. For the quarter ended September 30, 2016, we generated total investment income of $59.2 million. Net PIK interest, which represents PIK accruals recorded in excess of PIK payments received represented 5.9% of total investment income. Net investment income was $25.7 million for the quarter or $0.18 per share.

During the quarter ended September 30, we closed $123 million of investments in five new and five existing portfolio companies and we received $134.4 million in connection with the repayments and exits of 11 of our debt investments. We also received an additional $26.3 million in connection with paydowns, syndications and sales of debt investments. As of September 30, 91% of the portfolio at fair value consisted of debt investments, 78% of the portfolio was invested in senior secured loans and 81% of the debt portfolio consisted of floating rate securities.

FSC's joint venture with an affiliate of Kemper Corporation generated an 11.3% weighted average annualized return on FSC's investment during the September quarter. As of September 30, 2016, the joint venture had $338.5 million of assets, including investments in a range of one stop and senior secured loans to 37 portfolio companies.

For the September quarter, the weighted average yield on FSC's debt investments, including the joint venture return, was 10.4% with a cash component of the yield making up 9.6%. At September 30, 2016, the average size of a portfolio debt investment was $19.7 million and our top 10 portfolio company investments represented 28.5% of total assets.

As a reminder, last month, our Board of Directors declared monthly dividends of $0.06 per share for December, January and February, consistent with the last six quarterly dividends. We expect our Board of Directors to continue declaring monthly dividends on a quarterly basis subject to various factors, including Company performance, capital availability, level and timing of share buybacks, as well as general, economic and market conditions. I will now turn it back over to Robyn.

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

(Operator Instructions). Leslie Vandergrift, Raymond James.

Good morning. Just a quick question. You mentioned in the prepared remarks that M&A was slower this quarter possibly because of global concerns, possibly the election. I know we had a lot going on running up and to worries before the end of the third. Was there a specific issue there that you saw the slowdown and/or is this an issue with some private equity sponsors? And then going forward, what does that do to repayment expectations for the next year?

I don't think there is a specific issue. As Todd said, we are not seeing deals in our portfolio that we think present good risk-adjusted returns. That is what we saw for this quarter. But I don't think it was a specific issue.

Okay. But with the M&A slowing down, do you see repayment slowing down as well? I know you expect leverage to get back down to target, so expect net repayments at least in the short term? Is that going to be a little bit slower than originally expected or is that just a one-quarter off thing?

So for the December quarter, we expect to get back within our leverage range as we are foreseeing more repayments this quarter, but that is with respect to the December quarter. We have not projected beyond that.

All right. My last question would be on AdVenture. It is one of the newer nonaccruals, went on cash on accrual this quarter. First lien all the way onto cash, but can you just give some more color on that? I know with the other ones it is oil and gas and then just a PIK nonaccrual on the other new one, but advertising company, get some color on that one?

Yes, this is Ivelin. AdVenture is our investment in -- it is a marketing services company that services clients in the for-profit education space. So as you might imagine, that space is getting a lot of scrutiny and a lot of negative publicity. Clients have been cutting back budgets so that gives us exit -- the revenues at AdVenture. We are first lien unit tranche investment there, we are the sole capital structure so we are in a good position to craft a solution for the business going forward and we're working with a company that is sponsoring and effectuating a solution. So there will be more coming down the road as we get more -- as we get closer to a resolution there.

All right, perfect. Thank you.

Christopher Testa, National Securities.

Good morning. Thanks for taking my questions. Just aside from the top-level management changes, what additional personnel changes are occurring at the Company? Are you shaking things up in the origination and underwriting given the nonaccruals have been elevated this year?

So look, we are excited for Patrick to join. We think that his 25 years investment experience will be a huge asset to us, but we do not have any other changes planned at this time. Patrick is going to come in and he is going to help us, but we're always striving to stabilize NAV and enhance returns and we are going to work hard to do that, but there is no other changes planned at this time.

Okay. Just on you guys discussing putting in a lookback feature with the incentive fee, congrats on that, that is definitely a major positive. Just could you give us any additional details on when exactly that is going to first begin, as well as if that is going to be a three-year lookback cumulative and whether it is going to start from going forward when you implemented or if it is going to look back retroactively?

We are going to announce the details on that early in the year; we are still working out the details. We need Patrick to come on board to finalize that. We think that will be most appropriate, so we look forward to giving you answers to all those questions in early 2017.

Okay, great. Just on the new repurchase authorization, I know you guys have mentioned in the prepared remarks being flexible in terms of the size of that, but why was it so much lower than the previous authorization given the stock is so heavily discounted still?

So earlier in the year, I believe this February, we said we intended to repurchase $50 million worth of shares of which to date we have done about $37.5 million, so there is $12.5 million to go and our authorization was about to expire so we wanted to make sure that we had authority to complete the 50. So for the moment, that is what we have done. We've put in the authority to complete the 50 and then in early 2017, we expect to further evaluate where we are and once Patrick comes on board and we are not saying there won't be any more, but this is just simply to complete the 50 that we wanted to do.

Okay, great. That is all for me. Thanks for taking my questions.

(Operator Instructions). Ryan Lynch, KBW.

Good morning. Thank you for taking my questions. Just a follow-up on the previous question about the management agreement. You mentioned making the change, implementing the total return hurdle, which would be I think a great provision and very beneficial for shareholders. So is that the only new provision that you guys were looking at implementing or were you guys also looking at making any changes to the fee structure?

Look, there might be additional changes. I don't want to say there will or won't be, but we are going to deal with that in early 2017, so when Patrick comes on board and I can't give any more detail at this time.

Okay. And then with Ivelin stepping down, obviously that leaves a vacancy for the President, Chief Investment Officer role. Is that a role that you guys are looking to fill with somebody externally or promote somebody internally or is that role just going to go unfilled going forward?

Right now, we have brought Patrick on board who is going to lead our investment strategy and that is the only change planned at this time.

Okay. And then just one last one about the senior loan fund. That is actually -- that fund has been shrinking from an AUM actually in the fund over the past year quite considerably. So what is the outlook for that fund? Why did it shrink so much over the last 12 months and what is the outlook for the size of the AUM in that fund going forward?

It is Ivelin again. So the Kemper JV is a fund that has contributed tremendously to our return over the last couple of years and Kemper is a good partner of ours (inaudible). So every deal that we see through the platform we show to Kemper and we have to pass through our screens, but also it has to pass through theirs. So you might imagine (inaudible) there's just not a lot of deals that we get excited about, not a lot of deals that they get excited about. It's difficult to make things fit into the senior loan fund. We are seeing some additional opportunities that are coming up in the pipeline that might fit that fund, so we are optimistic that we will continue at least maintaining and hopefully increasing the size there. But you are right; it has come down and it is more of a defensive focus given the market environment than anything else.

Okay, that is all from me. Thanks for taking my questions.

Jonathan Bock, Wells Fargo Securities.

Good morning and thank you for taking my questions. Bernie, as it relates to the total return hurdle, certainly folks understand that it can be valuable, but it is certainly valuable when instituted ahead of credit losses. And so what we have seen in terms of book experience is about $55 million in realized losses this quarter, maybe $44 million prior. I mean a total of $83 million down. Would it make sense to retroactive or backdate the total return hurdle to include the losses that have been experienced from midyear of 2016 on?

Good morning, Jonathan. As we stated on our remarks, Patrick and the entire team and the Board are committed to making shareholder-friendly changes to our fee structure, including the total return hurdle and we plan on finalizing those changes early in the new year and announcing them. We will give those details in 2017.

Appreciate it, but the value of the total return hurdle comes again before the losses occur, not setting it afterwards. So I would imagine from a shareholder-friendly standpoint, you guys will take into account the losses that have been incurred to date. That is all my questions. Thank you.

Thank you, Jonathan.

Thank you and I am showing no further questions at this time. I would like to turn the call back to management for closing remarks.

We want to thank everyone for joining us on the call this morning and we look forward to speaking to you again early in the new year.

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