BlackRock TCP Capital Corp (TCPC) 2018 Q2 法說會逐字稿

Ladies and gentlemen, good afternoon. Welcome, everyone, to the BlackRock TCP Capital Corp. Second Quarter 2018 Earnings Conference Call. Today's conference call is being recorded for replay purposes. (Operator Instructions)

And now I would now like to turn the call over to Katie McGlynn, Vice President of the BlackRock TCP Capital Corp. Global Investor Relations team. Katie, please proceed.

Thank you, Nicole. Before we begin, I'll note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance.

Forward-looking statements involve risks and uncertainties, and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today and are subject to change without notice. This morning, we issued our earnings release for the second quarter ended June 30, 2018. We also posted a supplemental earnings presentation to our website at tcpcapital.com. To view the slide presentation, which we will refer to on today's call, please click on the Investor Relations link and select Events and Presentations.

I will now turn the call over to our Chairman and CEO, Howard Levkowitz.

Thanks, Katie. I'm here with our TCPC team. And we thank everyone for participating on our call today. I will begin with a review of our second quarter highlights, an overview of our portfolio activity and an update on the previously announced transaction between BlackRock and our external adviser. Our CFO, Paul Davis, will then review our financial results for the second quarter. After Paul's comments, I will provide some closing remarks before opening the call to your questions.

Now, let's begin with highlights from the second quarter, which are summarized on Slide 4 of our presentation. We delivered another strong quarter of originations in the second quarter totaling $125 million as new and existing borrowers continue to rely on our deep industry knowledge and our flexible and tailored financing solutions.

As shown on Slide 5, we earned net investment income of $0.41 per share in the second quarter, outearning our dividend by $0.05 and extending our record to 25 consecutive quarters in which net investment income exceeded our dividend. And today, we declared a third quarter dividend of $0.36 per share payable on September 28 to holders of record as of September 14.

We also renegotiated terms on our credit facilities during the second quarter, reducing borrowing costs and improving our overall cost structure for shareholders.

Turning to our investment portfolio on Slide 6. At quarter-end, our portfolio had a fair market value in excess of $1.6 billion, 92% of which was in senior secured debt. We held investments in the 97 companies across a wide variety of industries. Our largest position represented only 3.2% of the portfolio, and taken together, our 5 largest positions represented only 14.2% of the portfolio.

As you can see on the chart on the left side of Slide 6, our recurring income is distributed across a diverse set of portfolio companies. We are not reliant on income from any individual portfolio company, in fact, on an individual-company basis, over half of our portfolio companies contribute less than 1% to our recurring income.

Additionally, over the last several years, we have positioned our portfolio to benefit from a rising interest rate environment. At quarter-end, 92% of our debt investments were floating rate, as demonstrated on Slide 7. Our successful efforts to position our portfolio have been further enhanced by our predominantly fixed rate liabilities.

Finally, in April, we announced that adviser TCP had agreed to merge with a subsidiary of BlackRock. We successfully closed the transaction on August 1 and are pleased with the strong investor support.

As part of the transaction, TCP Capital Corp. was renamed BlackRock TCP Capital Corp. Upon closing the transaction, we also announced the appointment of Karyn L. Williams as an independent Director to the TCPC board. Karyn has an extensive background in investing governed risk management, and we look forward to leveraging her experience.

Moving on to our portfolio performance. While the overall portfolio remained strong, NAV declined from $14.90 to $14.61 in the second quarter, primarily caused by markdowns on 4 of our holdings, Kawa, Real Mex, Green Biologics and AGY, which offset our NAV gain of $0.10 in the first quarter. While we're disappointed in the performance of these 4 positions, they represent distinct and unrelated write-downs on challenged positions we have discussed at length in prior quarters, which coincidentally occurred this quarter.

The largest write-down was on our Kawa position, where the sale contract was renegotiated. Real Mex has suffered from the increased cost of operating in California and was marked down in the second quarter in connection with its upcoming 363 auction. Despite an equity infusion earlier this year, Green Biologics has not met projections. And in the case of AGY, the markdown was driven by volatility in the end markets but the company continues to be a fundamentally good business.

Excluding the markdowns on these positions, NAV was flat quarter-over-quarter and the credit quality of our portfolio remained strong with debt from only one portfolio company on nonaccrual, which represented 0.3% of our portfolio at fair value.

Slide 8 provides an overview of our portfolio activity in the second quarter. Of the $125 million deployed, $111 million or 88% was in senior secured loans and notes. These include investments in 6 new companies and 4 existing portfolio companies. Follow-on investments in existing portfolio companies continue to be an important source of investment opportunities and reflect our strong borrower relationships in the value we deliver to them.

Our top 5 investments in the second quarter reinforce our commitment to maintaining a diverse portfolio and lending at the top of the capital structure. They include, a $24 million senior secured loan to Domo, a data management company specializing in business intelligence tools and data visualization. A $17 million senior secured loan to Adesto Technologies, a semiconductor manufacturer. A $16 million senior secured loan to Amteck, a national design build electrical contractor. A $15 million senior secured loan to Freepoint Commodities of physical commodities merchant, and a $10 million aircraft secured loan to Mesa Air, a U.S. regional airline, we know well and have financed for a number of years.

Our other investments in the second quarter were spread across a variety of industries, including marketing, sports, technology, insurance and engineering and construction. Dispositions in the second quarter totaled $113 million and included a $19 million payoff of our loan to Caliber Homes, a $15 million payoff of our loan to Bon-Ton and a $7.5 million payoff of our loans to Videology. Both Bon-Ton and Videology generated significant prepayment income, and the sale of our Gogo notes generated a significant gain.

News investments in the quarter had a weighted average effective yield of 10.8%, and the investments we exited during the quarter had a weighted average effective yield of 10.6%. The overall effective yield on our debt portfolio at quarter-end increased to 11.6%.

Given the competitive pricing environment, we're very pleased to continue generating consistently strong risk-adjusted returns on our investments, as we have done for 2 decades and throughout several market cycles.

TCPC's consistent and strong performance has been a function of our long-term relationships with deal sources, portfolio companies and other constituents. Our deep industry knowledge and our disciplined approach to sourcing, underwriting and managing our portfolio.

As shown on Slide 9, our dividends have returned $9.20 per share since our IPO.

And as demonstrated on Slide 10, TCPC has outperformed the Wells Fargo BDC Index by 36% over the same period.

As you know, in the past few years, there have been many new entrants into direct lending and substantially more capital seeking investment opportunities in the middle market. Against this backdrop, we are very excited to partner with the largest-global asset manager. As part of BlackRock, we will benefit from greater scale and resources, an enhanced ability to source transactions, a lower administration expense ratio and access to new technology capabilities.

Finally, we will be well positioned to continue to attract the best talent to our team. We have already been working closely with our BlackRock colleagues throughout this transition period and are excited for the opportunities ahead.

Now, I will turn the call over to Paul who will discuss our second quarter financial results. Paul?

Thanks, Howard. Good morning, and good afternoon, everyone. Starting on Slide 14. Net investment income of $0.41 per share exceeded our dividend of $0.36 per share. This continues our more than 6-year record of covering our dividend every quarter, since we went public. Over this period, on a cumulative basis we have also outearned our dividends by an aggregate $28.7 million or $0.49 per share, based on total shares outstanding at quarter-end.

Investment income for the quarter was $0.82 per share, substantially, all of which was interest income. Recurring cash interest was $0.66, recurring discount and fee amortization was $0.05 and recurring PIK income was $0.06. The remaining $0.045 per share was from prepayment income, including both prepayment fees and unamortized OID. Our income recognition follows our conservative policy of generally amortizing upfront economics over the life of an investment rather than recognizing all of it at the time the investment is made.

Operating expenses for the second quarter were $0.41 per share, and included incentive compensation of $0.10 per share, and interest and other debt expenses of $0.17 per share for net investment income of $0.41 per share. We realized net gains during the quarter of $0.7 million, primarily from the sale of our Gogo notes. As Howard noted, our unrealized losses of $20.5 million or $0.35 per share were primarily comprised of write-downs on 4 positions we discussed in the past.

That said, our credit quality remains strong with debt from only one portfolio company on nonaccrual at quarter-end, representing 0.3% of the portfolio at fair value.

Turning to Slide 17. We closed the quarter with total liquidity of $212.5 million. This includes available leverage of $184.4 million, and cash and cash equivalents of $27.6 million.

During the quarter, we were pleased to be able to reduce the interest rate on our TCPC funding facility by 50 basis points to LIBOR plus 2% through a combination of a stated rate reduction and optimized utilization after reducing the facility size, while also extending the maturity date to May 2022. We also increased the capacity of our SVCP 2022 facility to $125 million.

Outstanding draws on our $150 million SBA program remained at $98 million. Regulatory leverage at quarter-end, which is net of SBIC debt was 0.83x common equity on a gross basis and 0.8x net of cash and outstanding trades. With our stock trading at a slight discount to NAV during the quarter, we made modest share repurchases under our share repurchase program, which is based on an algorithm.

I'll now turn the call back over to Howard.

Thanks, Paul. Over our history, we've worked hard to ensure interests are closely aligned with our shareholders. Our origination income recognition practices are conservative, and we have one of the most shareholder-friendly fee structures in the industry. We continue to invest alongside our shareholders and members of the management team and board of directors have continued to purchase shares in the open market. Given this, as we consider the recently passed legislation that allows BDCs to increase their leverage cap from 1:1 to 2:1, we will ensure any change in our approach to leverage is in the best interest of our shareholders.

We've made no decision on this matter and will continue discussion with our shareholders, our board, our leverage providers and other constituents, and we'll keep you apprised of any decisions we make in the future.

Regardless of any changes in legislation, we will remain focused on fundamental credit analysis in generating superior risk-adjusted returns for our shareholders as we have done since our inception.

Now, I will briefly cover what we are currently seeing in the market. We continue to see strong demand for our lending solutions from middle-market companies across a wide variety of industries. We recognize that there continue to be increasing amounts of capital targeting middle-market lending. However, the middle market is broad and there are many fundamentally good companies that need access to the creative borrowing solutions we provide.

At this point in the quarter, our pipeline includes many transactions that are well within our historical yield range. Looking ahead, we continue to be well positioned for continued growth for several reasons. First, our nearly 2 decades of experience investing in middle-market companies across multiple market cycles. Second, our long-term relationships with deal sources and portfolio companies, which provides us with the ability to source unique investment opportunities. Third, our focus on credit quality and downside protection. Fourth, our low cost of capital and diverse funding sources, which provide access to a variety of attractively priced equity and debt financing alternatives. Fifth, our interests have always been and will remain closely aligned with our shareholders. And finally, our partnership with BlackRock will allow us to expand our market-leading private credit platform, with significant scale, resources, and geographic research that will enhance opportunities for our shareholders.

Looking to the future, our strategy remains the same. We will continue to focus on effectively deploying capital from our diverse and attractively priced funding sources to optimize our portfolio performance by generating a strong recurring earning stream, while we focus on capital preservation.

In closing, we're excited about the future. We would like to thank all of our shareholders for your confidence and your continued support. And with that, operator, please open the call for questions.

(Operator Instructions) And our first question comes from Chris Kotowski from Oppenheimer.

I guess my first question is as you were negotiating your credit facility, does it accommodate if you do, in fact, decide to go beyond the 1:1 leverage? Is that incorporated into the credit agreement that you just renegotiated? Or would having higher leverage require renegotiating that again?

Chris, thanks for the question. And you were accurate, it is morning here. So as we said on the call, we are in conversations with our leverage providers and our other constituents about this 2:1 leverage issue. We think we're generally well positioned, should we decide to make a change. We haven't yet made any decision. But that's something, we're very cognizant of clearly, because they are an important part of our capital structure, but I think we're well positioned in that regard.

Okay. And then, secondly, I noticed your -- the increased loans to Mesa show up as a whole bunch of little loans to -- on -- separate small loans and increased -- and you've been in and out of kind of aircraft finance in years passed. I was wondering is this a move back towards that sector? Or is this just a one-off opportunity?

We have been involved in that sector for over 15 years. We're very opportunistic, we have done transactions, mostly bilaterals, so just us direct to the carriers, with most of the major U.S. carriers over time, and we invest when we think there are good opportunities. We have a long-term relationship with Mesa, in fact, we've known management for over 2 decades, we've been financing them for a number of years. We're pleased to be able to continue to finance them. And the fact that this is structured as a series of individual loans, has to do with the structure of the underlying collateral, each one of these things is, sort of, a highly negotiated individualized transaction structure.

And our next question comes from Robert Dodd from Raymond James.

First one, a real simple one. Can you give us your spillover number because, obviously, you've been overrunning the dividend for a while? I just want to get a handle on what that spillover number is, ideally in gross terms rather than per share terms?

Sure. Since our IPO, we've outearned the dividend by $28.7 million, that's approximately $0.49 per share based on outstanding shares at the quarter-end. That's on a GAAP basis.

Got it. Got it. Yes, okay. One thing you mentioned, Howard, in your prepared comments when talking about BlackRock was potentially a lower expense ratio putting some of the expenses over a broader base. Obviously, this quarter, [I don't want to peck you] not including the management fees and the interest expense, it ticked up a tiny bit 53 basis points, it was 46 last quarter. Can you give us -- when you say lower expense ratio, I mean, how much are you talking about? Anything is good, but can you give us any color there?

Sure. That's not something that we're prepared to quantify today. As I know, you're aware that we did say in connection with the transaction itself that upon reaching $2 billion in assets, we would commit to have a lower expense ratio. We are not at $2 billion today, we're at $1.6 billion. Independent of the transaction it's always something we're very mindful of. There are certain costs in there including accounting and insurance and a few other things that are harder to control. But our hope is that -- and being part of the larger BlackRock platform that there will be other synergies as well and that's certainly something that we're looking to target.

Got it. Got it. On the prepay income side, obviously, it's volatile quarter-to-quarter, I'm just talking general trends here. I mean, is there an expectation that, that -- as rates rise maybe refinance activity slows down even more, is it reasonable to say that you -- what color can you give on, do you think that $0.05 is, kind of, an average long-run number or do you think that will, kind of, trend down a little bit at this point in the cycle with rates on -- having moved up and refinance activity may be easing?

Yes, Robert, it's Raj. I'll take that. I think the application of an average to our portfolio is very difficult. For instance, in certain segments of the portfolio, for example, some of these recurring revenue deals that we've been doing, they are not tied to a market cycle. I think, we were early in understanding the credit worthiness and distinctions of that business model. And, for instance, now a lot of the new participants are, kind of, catching up. And so you're seeing a prepay -- a little bit higher prepay in that segment of the portfolio than the others. And it's not tied to a market cycle, it's tied to perhaps a business model appreciation that our team has been on the early side of. So I think what we can say is that we tend to be a little bit earlier knowledge-based in picking spots, and then as others kind of come in and catch up, the prepay is a benefit we can get, that is harder to extrapolate to the portfolio overall with a numerical average. But I do think we expect to see some. In any given quarter, it's hard to predict a number over a distinct time period.

Got it. Got it. Very helpful. And then just one more if I can, on obviously, the relationship with BlackRock as you said, expands reach potentially globally. Arguably, and we can argue at this point, I think people will say you've got an underutilized 30% option bucket, right? That could actually get even bigger because there's 30% of assets if you do expand -- extend leverage. Do you expect the relationship with BlackRock to provide you opportunities to utilize that in a different way then you have historically or do you think that's just not on the cards?

It's Raj, again. I'll try to respond to that. So I would say, we agree with you that it's underutilized, and whether that's a coincidence or we're saving it for more unique things. I think it is a blend of both, and I would say we hope -- we are hopeful that we will be able to utilize it more opportunistically both on our -- in our own efforts but also, as complemented by the platform scale that BlackRock brings to us. As a comparison, I think their BDC has done a very good job of utilizing that basket, and so I think, it's logical to say that we'll be able to see more things and take advantage of a broader set of relationships that can lead to utilization of it. And we are certainly open and hopeful of doing that.

And our next question comes from Christopher Nolan from Ladenburg Thalmann.

For the TCPC funding facility, which is now L plus 200 from L plus 250. How much was the BlackRock relationship affecting that change in price?

Thanks for asking, this was actually something that we negotiated prior to the transaction closing. And so BlackRock, obviously, has vast relationships and we hope to benefit from those going forward. And you could never be certain what all is in people's decision-making, but this was something that was in place really prior to the closing of the transaction and our discussion with the lenders really before it became public.

Great. And then, what is -- Howard, what is the yield on new investments and the yield on those that are exited?

Yes, this is Paul, I'll take that. Our acquisitions during the second quarter, the yield on those was 10.8%, whereas the yield on dispositions was 10.6%, 10.58%.

And our next question comes from Ryan Lynch from KBW.

Just one question regarding the BlackRock acquisition. Obviously, they have another BDC they operate today. Can you just talk about does BlackRock -- broadly speaking, do they have any other either, I guess, investment teams or pools of capital that directly invest into middle-market private credit that you were going to be able to access that sort of deal flow and/or are there just other pools of capital potential there that maybe aren't investing today that you will now be able to maybe commit to large hold size and spread across those other pools at BlackRock with co-investment relief?

Yes, thanks for the question. As you know, we have exemptive relief here and have been able to co-invest across the TCP funds going back to 2006. One of the things -- one of the many things that makes the transaction with BlackRock attractive though is being able to access greater resources. And so being able to co-invest alongside of them will give us more ability to commit to deals. We're not looking to change the kinds of deals that we're doing but to be able to commit to larger holds on deals that previously we couldn't. And we expect to be able to work together with their team that does middle-market lending, together, in both originating and sourcing those transactions and to be able to have the synergistic benefit of the combined organizations.

And our next question comes from Fin O'Shea from Wells Fargo Securities.

Just to first touch on Mr. Nolan's question a moment ago, so with the facilities that you were previously negotiating, should we expect maybe you won't go knock on the doors right away but another potential leg down in one of your funding sources from a cost perspective?

Yes, we have great relationships with our lenders, many of them over long periods of time. And so we continue to always talk to them about how to optimize our facilities, we just redid them. We are always thinking about what is the most optimal way to finance our balance sheet. You've watched us over time diversify the right side of the balance sheet through a series of bonds, a series of credit facilities, convertible bonds and our SBIC facility, and will continue to look at those and see what makes the most sense, and we appreciate the value of these long-term relationships, clearly, being part of BlackRock now, will give us access to some things we didn't have before.

Sure. And then, can you kind of touch on the cadence of your platform growth? Understanding you've always been measured but also presumably, partnering with BlackRock would help you accelerate that if you wanted to. Can you kind of touch on that outlook? And then, if so will -- how -- what market will you be going? Will you be going more into, say, sponsor finance as opposed to the various, I think you -- creative borrowing solutions as you've always focused on with smaller companies?

Chris, it's Raj, I'll try and take that one. And I won't speak for our BlackRock colleagues but I think, they'll echo the sentiment that we very much, I think, will stick to the philosophy of not growing for the sake of growth, but doing it judiciously and really focusing on broadening the scope and the scale of the opportunity set. And with a greater set of opportunities even at a judicious hit rate, which will be very low, being diligent in the process, I think, will allow us to potentially grow the platform or the joint platform, however, you want to look at it. So we will not compromise the balance of our diligence and our discretion and protections that we focus on as a lender. I think since our initial IPO, with that same philosophy, I think we've been able to demonstrate some good consistent growth over the time frame so I don't think that will change.

In terms of the sponsor finance question, we actively work with a number of sponsors today, I don't know that I would characterize it as sponsor finance meaning, it's not so much a share of wallet, or a mandate to get x number of days from any one sponsor, it just happens to be the best institutional owner of a number of -- a broad number of the opportunities that we're looking at. And while our breadth and scale to serve that client, that target base is greater under the broader platform, I still think we will -- we won't change the notion of what requirements and what protections we want. It just happens to be with a group of sponsors that have a scalable opportunity set to work with. So hopefully, that answers the question, in the big picture, which is very much the same approach, but I think looking at a broader set of opportunities to apply that approach with.

(Operator Instructions) We have another follow-up from Christopher Nolan from Ladenburg Thalmann.

Does -- what sort of discretion does BlackRock enable the external manager of TCP to have, I mean, is it -- do you have an answer to anything in terms of hurdle rates or anything along those lines to BlackRock? Any clarification would be helpful?

Sure. Yes, let's start with this. BlackRock TCP Capital Corp. is a public company with an independent board, and so like other public companies, we were answerable to our board. With respect to the manager itself, it is the intent to keep managing BlackRock TCP Capital Corp. in the same manner that we managed TCP Capital Corp. before the deal. Utilizing same investment process, same people. We expect and intend to benefit from the greater resources, and from the combined staff and people who are already at BlackRock and doing similar kinds of things and being able to add that to a larger group. But there is no intent today to change our basic approach.

And our next question comes from Christopher Testa from National Securities Corporation.

Just curious, Howard, what have the preliminary discussions with BlackRock entailed. I mean, what's -- can you just give us an idea on what the primary focus has been? Has it been you discussing co-investment, new product offerings they could give you, scaling the platform and reducing costs. I mean, just curious kind of how you would kind of put those in order and what the discussions have been centered around?

Sure. All good and fair questions. Day 1, the goal is to keep executing the way that we have over time, and we've got 2 decades of experience in this business, TCPC, now BlackRock TCP Capital Corp, is in its 25th quarter as a public entity although, its predecessor entity was around for many years before that. And the goal is to keep doing what we've been doing with more resources, and to be able to increase the pipeline, take advantage of some of the things that they have to offer, as Raj talked about, we may consider doing some other things we -- with the 30% bucket although, that's something we've looked at over time before this as well. We've just been -- I think, had a very cautious approach to how we use that and wanted to make sure that it's something that really fit with our strategy.

So the way we think about it is, it really is a continuation of what we've been doing, albeit with the resources of the world's largest asset manager in many ways to help us do what we've been doing, both with respect to people, that are directly in this business and increasing our sourcing and just across the platform. So we don't see it being a radical change.

Got it. Okay, that's helpful. And as you guys are debating internally on whether or not to reduce the asset coverage? In terms of -- when you're discussing it the reasons for not doing it, what's at the top of that list? What is, I guess, the biggest sticking point for you guys with not just voting for the reduced asset coverage?

Sure. It's -- investors have signed up for what we have today, and so we are very cognizant of that, and one of several reasons that we didn't rush to make any change was we wanted to let this digest, I think we've been very clear this wasn't something we pushed for, it has now happened, we've seen a number of the BDCs adopt it, we've seen the market react to it, and from our perspective, it's been very important to hear from our shareholders, hear from our board, hear from our lenders, hear from other constituents about how people are thinking about this. Our business model works well today, so we didn't see any urgency in adopting it, and as we think about it, we -- thinking about our cost of capital, any impacts or changes it might have to our funding, thinking about investor perception, those are the things that I think we're really focused on. In terms of operating the business model, it wouldn't take much of a change in our nonpublicly traded part of the business. We're doing things at different yield levels, so clearly, that could be an option also. But we just wanted to really take all of this in and make sure we were making a fully considered decision before we do anything at all if we are going to do anything.

Got it. That's great detail. And definitely, I respect you guys taking the time to think this through unlike some of your peers. Now, just you had talked about the potential of the 30% basket been utilized more, and then and there is the potential, obviously, we were just talking about reducing asset coverage. Is there a potential that if you reduce asset coverage, you still make use of the 30% bucket with something like a JV or would a JV in the 30% bucket be used kind of as a substitute for the reduced asset coverage to increase your economic leverage?

I think there is a potential for both I think at some -- and we've looked at a number of these in the past, and at some level, in my mind the notion of what the JV specifically is targeting, may drive some of that, the notion of where you can get better leverage and cost of leverage, whether it's on balance sheet or through a JV as part of that decision. How you can source the right assets, depending on where -- all of that, I think we can -- we would consider but I do think both business models are feasible with the specifics being the key consideration points.

And I'm showing no further question at this time. I would now like to turn the call back to Howard Levkowitz, for any further remarks.

Thank you. We appreciate your questions and our dialogue today. I'd like to thank of our experienced dedicated and talented team of professionals at BlackRock TCP Capital Corp. Thanks, again for joining us. This concludes today's call.

Ladies and gentleman, thank you for your participation in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.