Portman Ridge Finance Corp (PTMN) 2009 Q2 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to the Kohlberg Capital Corporation's Second Quarter 2009 Earnings Conference Call. An earnings release has been distributed earlier today. If you did not receive a copy, the release is available on the Company's website at KohlbergCapital.com in the Investor Relations Section.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today, Monday, August 10, 2009. This call is also being hosted on a live webcast which can be accessed at our Company's website, www.KohlbergCapital.com in the Investor Relations Section under events. In addition, if you would like to be added to the Company's distribution list for news events, including earnings releases, please contact Denise Rodriguez at 212-455-8300.

At this time, management would like me to inform you that certain statements made during this conference which are not historical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Kohlberg Capital Corporation believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that the expectations will be attained. Factors and risks such as those described in the risk factors section of our 10-K and sections of our Forms 10-Q and other SEC documents filed during the course of the year could cause actual results to differ materially from expectations.

Now at this time for opening remarks, I would like to introduce Chris Lacovara, Chairman. Please go ahead.

Thank you. Good afternoon and thank you all for joining Kohlberg Capital for a review of our second quarter 2009 financial results. I will open the call with some general comments about the financial performance of our middle-market lending and asset management businesses. I will then turn the call over to Dayl Pearson, our Chief Executive Officer, who will discuss our investment portfolio in more detail. After that, our Chief Financial Officer, Mike Wirth, will provide a recap of our second quarter financial results and performance. We will then open the line up for your questions at the end of the call.

For the Company's second 2009 fiscal quarter, net investment income per common share was $0.29, compared to $0.32 per share for the first quarter of 2009. This modest reduction in net investment income from the preceding quarter was due primarily to lower average portfolio balances as loans prepay and we reduce our outstanding debt.

Net investment income after giving effect to realized losses during the quarter equaled $0.15 for the quarter. Realized losses of $3.1 million, or $0.14 per share, were primarily the result of the write-off of approximately $2.2 million related to the closure of our planned distressed debt investment platform, PKSIL LLC.

The remainder of realized losses were due to the sale of certain assets below their original cost and were not the result of defaults on loans in our investment portfolio.

Kohlberg Capital declared and paid in cash a dividend for the second quarter of $0.24 per share, unchanged from the prior quarter. As these figures indicate, we continue to maintain our core strategy of funding 100% of our dividend with net investment income without a return of capital.

In addition, we have accumulated approximately $4 million, or $0.16 per share, in undistributed income to date in 2009.

Net asset value per share was $11.09 at quarter end as compared to $11.68 as of December 31, 2008. Trading values in the loan market have improved in recent months, and we believe that the downward pressure on our NAV as a result of the distressed market conditions we saw in 2008 has moderated significantly.

The decrease in our 2009 second quarter net investment income from the second quarter of 2008 is indicative of the continuation of several challenges facing our company and the BDC sector in general as a result of current market conditions.

First, with our stock currently trading at a substantial discount to our net asset value, it is difficult and likely not advisable to raise new capital, which we could otherwise invest at what are currently very attractive interest spreads to grow our dividend.

Second, with our credit facility in amortization, which I will discuss further later in this call, all principal and net interest on the underlying assets securing the facility are used to pay down the outstanding balance and are therefore not available for investments or for distributions to our shareholders. As a result, we had to sell a limited number of assets in the second quarter for cash management purposes, resulting in a modest realized loss.

Third, some of our portfolio investments in the subordinated debt and preferred stock of collateralized loan obligations, or CLO funds, continue to face some challenges in the current recessionary environment. Although all of the CLO funds in which we invested continue to experience manageable default rates and strong net interest cash flows, beginning in the first quarter we saw a significant number of rating downgrades on the underlying loan assets, particularly in the older CLO funds, although the pace of such downgrades has decreased significantly in the past couple of months.

These rating downgrades reduced the carrying value of some CLO fund collateral and may result in a temporary suspension of cash payments to the junior fund securities which KCAP holds, temporarily reducing KCAP's related investment income. Fortunately, these challenges relate primarily to investments in CLO funds raised and invested prior to the onset of the credit crisis in late 2007, which represent only 14% of our total CLO investment portfolio, and less than 1.5% of our total assets.

Our investments in the Katonah X and Katonah 2007-1 CLO funds, which represent 86% our CLO investments, fortunately have experienced much less significant rating downgrades and continue to make cash distributions to KCAP on a quarterly basis.

Turning to our asset management business, Katonah Debt Advisors, or KDA -- as of June 30, 2009, KDA had $2.1 billion of assets under management. Our 100% ownership of KDA was valued at $56.5 million based on its assets under management and prospective cash flows.

KDA produced a net pretax income of approximately $1 million year to date for 2009. However, KDA made no distributions to KCAP during the first half of 2009 as compared to a $350,000 distribution recognized as investment income in the first half of 2008.

KDA has also been impacted negatively by the performance of its managed CLOs, as three of these funds have deferred payments of certain management fees due to the rating downgrades on underlying loan assets previously mentioned. However, since these fees continue to accrue, we expect that KDA will receive them in future quarters as these funds recover.

Accrued fee income available for future released KDA, and thus available to dividend to KCAP as income, was approximately $2.7 million at the end of the second quarter of 2009.

Moving on to the balance sheet, at quarter end, we had debt outstanding of approximately $234 million under our secured credit facility. We have been, and continue to be, in compliance with all of our facility covenants, including our leverage ratio, and our leverage continues to decrease from regular principal and interest collections.

The credit facility is nonrecourse to KCAP and is secured by approximately $305 million of assets at current estimated fair value, consisting primarily of senior secured loans and representing approximately 55% of our gross investment income. The remaining $172 million of our assets, representing 45% of our gross investment income, are unpledged and outside of the credit facility.

We believe that we have sufficient cash and liquid assets to fund normal operations and continuing dividend distributions through the existing maturity of the facility in September 2010. We have been in discussions with our lenders with respect to an amendment to the facility, under which this maturity would be extended in return for an increase in the interest rate and the possible pledge of additional collateral currently outside the facility.

Notwithstanding the continuing of these negotiations, the facility lenders have recently attempted to assert that the Company is in technical violation of certain terms of the facility and to unilaterally impose an increase in the interest rate. Mike Wirth will comment on this issue in more detail in a few minutes, but the Company strongly believes that it remains in compliance with all facility terms and that the assertion of a technical default is completely without merit, and that the lenders are not entitled to an increase in the interest rate absent a satisfactory amendment.

And with that, I would like to turn the call over to Dayl, our President and Chief Executive Officer. Dayl?

Thank you, Chris. I'll start with some highlights of the quarter and then review our portfolio of middle market corporate loans and equity.

At June 30, our net asset value was approximately $241.2 million, or $11.09 per share, down from $250.3 million, or $11.68 per share, at the end of the first quarter. The severity of the current recession has caused most financial stocks to trade at a significant discount NAV as a result of concerns about credit losses. Our strategy of diversity and focusing on less cyclical industries, in primarily first lien positions, has benefited us in the current environment despite the severity of the downturn. I'll talk a little bit about credit quality later.

We ended the quarter with total assets at fair value of $478 million, a decrease of approximately $45 million relative to year-end 2008. The decrease is attributed to lower asset valuations and the fact that we are in the process of delevering, and using principal repayments on our investments in selected sales to pay down our financing facility, as Chris mentioned earlier.

Looking at the composition of our investment portfolio, our portfolio quality continues to hold up relatively well. At the end of the second quarter our debt securities totaled approximately $339 million and represented 73% of the investment portfolio. As in the past, first lien loans represented the largest percentage of our debt securities at about 53%, little change from the end of the previous quarter. Second lien loans represented an additional 37% of the portfolio, which meant, taken together, approximately 95% of our loan portfolio consisted of secured debt.

By industry, our middle-market portfolio remains very diversified across 26 different industries with very little exposure to construction, real estate, retail, or finance.

The debt securities portfolio comprises 84 issuers with an average loan exposure of approximately $4 million. At June 30, our 10 largest portfolio companies accounted for approximately 34% of portfolio at fair value, the same as at the end of the first quarter. If you exclude our investments in Katonah Debt Advisors and the CLOs, our 10 largest portfolio companies represent approximately 17% of portfolio fair value.

At June 30, the weighted average yield on the loan and bond portfolio was approximately 6.3%. And approximately 7% of our debt securities are fixed rate, with an approximate average fixed rate of 11.2%.

As we noted earlier, credit quality remains relatively good. During the second quarter, our hard watch list increased from seven to nine issuers. We currently have six issuers on nonaccrual status. Two of these issuers, each related to the automobile industry, defaulted on their loans during the second quarter. Despite this, we continue to see prepayments at or above par, which supports our contention that the unrealized losses in our portfolio do not reflect the economic reality of our portfolio. Since the beginning of the year, we have received over $12.8 million in prepayments at par or above.

Currently, there is very little activity in the primary market as our private equity partners are facing their own constraints in accessing capital and secondary market investments aren't offering attractive returns.

And now I will ask Mike to walk you through the details of our second quarter performance. Mike?

Thank you. Dayl. Good morning, everyone. Starting with our income statement, in the second quarter of 2009, we reported net investment income of $6.4 million, as compared to $7.7 million for the same period of 2008. Total investment income for the second quarter was $9.5 million, for which approximately $6.9 million was interest income from our debt securities investments and $2 million from our investments in CLO fund securities.

As compared to the immediately preceding first quarter of 2009, total investment income declined approximately $600,000, primarily due to lower average debt securities balance and slightly lower interest yields on the portfolio.

Total expenses were approximately $3.1 million, nearly half of which related to interest expense on our lending facility. Total expenses decreased by $1.5 million from the second quarter of 2008, due to lower interest rates and outstanding balances under our credit facility, as well as a $682,000 reduction in operating expenses equal to about $2.7 million on an annualized basis.

Across the board, expenses for the second quarter of 2009 are less than those for the same quarter of the prior year due to expense reductions in compensation, professional fees, and G&A expenses.

Net investment income and net realized gains and losses for the quarter were $3.3 million, or $0.15 per share.

For the second quarter, we declared a $0.24 dividend, which was paid in cash on July 29, 2009, to holders of record as of July 9, 2009. This second quarter dividend of $0.24 was covered by the Company's net investment income of $0.29 per share.

Net unrealized losses for the second quarter were approximately $6.5 million, or $0.29 per share. This consists of approximately $10.4 million in decreased fair value of our corporate securities and equities, reflecting market conditions, and an increase in fair value of our CLO investments of approximately $5.2 million. The increase in the value of our CLO investments is primarily due to our opportunistic purchase of the DD-rated tranch of Katonah 2007, which is generating a 60% IRR investment cost.

Moving on to the balance sheet, total assets at quarter end were $478 million. Stockholders' equity, or net asset value, was $241 million. As a percent of total assets, debt and liabilities outstanding were approximately 50% of total assets, or equal to an average coverage ratio of about 203%.

For determining covenant compliance on our facility, a leverage ratio covenant of at least 1 to 1 must be maintained based on the ratio of the facility outstanding balance and the most-recent GAAP stockholders equity balance as of the facility outstanding balance determination date. The Company has been, and continues to be, in compliance with this leverage covenant ratio as of June 30, and continuing to date.

At quarter end, we had debt outstanding of $234 million under our secured credit facility. Weighted average interest rate on weighted average outstanding borrowings was approximately 2.2% during the second quarter, compared to 3.8% for the same quarter of last year and 2% for the first quarter of 2009.

Since year end, the facility has amortized down from approximately $262 million to the current balance of $234 million. The credit facility is nonrecourse to KCAP, and is secured by approximately $305 million of assets at current estimated fair value consisting primarily of senior secured loans and representing approximately 56% of our gross investment income.

The remaining $172 million of our assets, representing 44% of gross investment income, are unpledged and outside the credit facility.

In late September 2008, the Company was notified by the lenders that the liquidity banks providing the underlying funding for the facility did not intend to renew their liquidity facility to the lenders. As a result, the facility entered a two-year amortization period, during which all principal and net interest collected from the assets pledged as collateral for the facility are used to amortize the facility through a termination date of September 29, 2010. There are no fixed required amortization payments during this two-year amortization period.

Because our debt balance will continue to amortize in future quarters through principal and net interest collections on pledged loans, we expect our leverage ratio to continue to improve. Since the fourth quarter of 2008, we have been, and are currently in negotiations with, the facility providers with respect to an amendment which would extend the term of the facility in return for an increase in the interest rate and a potential pledge of additional assets to which the facility currently does not have recourse.

As mentioned before, notwithstanding these discussions, in June 2009, the providers of our facility attempted to assert that we were in technical breach of certain terms of the facility. Specifically, they alleged our failure to properly determine ratings on certain pledged loans resulting in multiple incorrect calculations under the terms of the facility.

The lenders also stated that as a result of such technical default, they are entitled to interest payable at a higher rate, equal to the prime rate plus 75 basis points, applicable to periods during which such default has occurred and is continuing. We believe that the lenders' claim that a breach has occurred is without merit, and have responded by denying any breach and have stated that their actions seeking to increase the interest rate payable are in violation of the facility agreement.

Notwithstanding the asserted technical default and our response, we continue to be in discussions with the lenders with respect to a mutually agreeable amendment and extension of the facility. However, there can be no assurance that such agreement will be reached.

As we mentioned before, between cash on hand, liquid investments, and net income on assets not secured by the facility, we anticipate that we have sufficient cash and liquid assets which could be sold as needed to fund normal operations and continue dividend distributions. The aforementioned discussions on second quarter results are also discussed in the 10-Q that has been filed earlier today. Our past quarterly 2009 10-Qs and our 2008 annual 10-K are available at our website, www.KohlbergCapital.com, or at www.sec.gov.

And with that, I'd like to turn the call back to the operator to start the Q&A session. Operator?

Thank you. (OPERATOR INSTRUCTIONS) Greg Mason, Stifel Nicolaus.

Good afternoon, gentlemen. Could you put in layman's terms what the debt holders are alleging -- is it a leverage issue? Is it a borrowing base issue? What exactly are they saying is wrong?

It's really a borrowing base issue as far as certain-- there's certain buckets that we have to have covenants with and their assertion is that some of those buckets are not being calculated appropriately.

Yes. Greg, this is Dayl. It's a technical issue related to the agreement and it's sort of confusing to us, to be honest with you, since it wasn't clear from the default letter what it was exactly that they were referring to. But somehow it relates to not calculating the borrowing base correctly because of disputes over ratings. It is not related to our leverage covenant.

Okay. And then, can you talk about-- if you're contesting this letter, how does that impact what you actually pay? You said the default rate's prime plus 75, but what do you actually pay next quarter, and what comes into GAAP if you're contesting this?

We are actually paying, under protest, the increased rate. And for GAAP purposes, we're going to be recording that same expense.

Okay. And then, can you talk a little bit about the CLOs -- Katonah X and 2007-1 are not trapping cash but you say some other ones are. Since those are the two biggest ones, can you walk us through what's the likelihood that those either trap or don't trap cash? And how close are those two facilities in this environment?

We feel that we have a comfortable cushion there. And again, because their vintage is later and because the pace of rating downgrades has slowed so much -- and particularly the large investment in Katonah 2007-1, a lot of those assets were accumulated after the onset of the recession and credit crisis -- we feel pretty comfortable those should both continue to pay.

And for those other CLOs that are trapping cash, is that still accrued into GAAP earnings or is that now excluded since they've trapped cash?

They're excluded at this point.

They only book when it's actually received.

Okay. And then, can you remind me again when the settlement with JP Morgan is completed and you'd have free cash flow to generate back up from Katonah?

That lasts through the course of this year. After the fourth quarter, the cash that Katonah has will be free from having to pay down JP Morgan.

And would you be willing to tell us how much is left on that settlement between now and the end of the year?

It's $1.5 million. Two more payments of $750,000.

Okay. And you think you'll have no problem making those two payments?

We don't anticipate any issues with that.

Okay. And then, one last quick question, then I'll hop out of the queue. Can you talk about the hard watch list of nine investments and nonaccrual six investments -- how much is that on a cost dollar basis?

This would be as of-- this is going to be a little bit hard because this will be as of June 30 -- we've actually had a couple of them pay down. But-- par of 31.5.

Yes, it's under $30 million of par today.

Okay. Is that the nonaccrual or the hard watch list?

That's the hard watch list.

Okay, great. Thank you very much, guys.

(OPERATOR INSTRUCTIONS) John Hecht, JMP Securities.

Thanks for taking my questions. To conclude from that last question there, what is the nonaccruals and the hard watch list as a percentage of fair value and cost? If you have those stats handy -- I think you mentioned the hard watch list was just about $30 million par.

If you give me a second-- you can go ahead and ask your next question and I'll come back and tell you. (Laughs)

Okay. The next question is with respect to the loan funding and service agreement. I know it's nonrecourse -- can they force you to do anything with any of the unpledged assets in the worst-case scenario, or they can only force actions to take place within pledged assets?

They only have recourse to pledged assets.

Okay. And then, you'd mentioned they placed you in technical violation, but you also suggested there's also negotiations going on, trying to resolve it and extend it. Can you give us a sense where you are in those negotiations? I mean, are we just at a couple of sticking points, a few basis points off in pricing, or is it too premature to suggest that you might get resolution to that?

Actually, it's relevant to your previous question. I think the big issue is a request by the lenders that we pledge all the rest of the assets without making changes to the document that greatly reduce the chances of a default. And I think that's a very important point. Our Company is viable just based on the unpledged assets even if there is a default, which there isn't. But to create a situation in which all the assets are pledged and then there could still be a default would put us in a situation of some of the other BDCs that have had some real issues, and we're not willing to do that.

I think the second point is that there comes a point at which, if the interest bill is increased enough, it's frankly not profitable for the shareholders to maintain that facility. Now, I don't think that's the primary issue. I think the primary issue is our ability to continue to operate on a stand-alone basis post-amendment.

Okay. And then, it looked like the facility amortized about $30 million this quarter. Was there anything unique in that or is that a decent run rate to think of this amortizing?

For the year I think it was $30 million--

Excuse me -- for the first two quarters; correct.

In the first quarter, we did sell some assets.

A little bit of sales in the second, but a lot-- (inaudible)

Most of (inaudible) there was normal amortization. As I said, we had almost $13 million of prepayments.

Some of it was amortization. The calculation--

And we've had more amortization subsequent to 6/30 as well. So it's actually down from that level.

Okay, so that seems like a reasonable run rate to run that off. And then, do you have the answer to the--?

Yes. In default, we had 1.3% to fair value. And in total, the hard watch list and the defaulted assets, it was 3.4%.

And that's as a percentage of fair value?

That's a percentage of fair value, yes.

Okay, great. Thank you guys very much.

Okay, John.

(OPERATOR INSTRUCTIONS) There are no further questions at this time. I'd like to turn the conference back over to our speakers for any concluding remarks.

Thank you all for your participation in the call and for your continued support.

Once gain, this does conclude today's conference call. We do thank you for your participation.