BlackRock TCP Capital Corp (TCPC) 2022 Q2 法說會逐字稿

Ladies and gentlemen, good afternoon. Welcome everyone to BlackRock TCP Capital Corp. Second Quarter 2022 Earnings Conference Call. Today's conference call is being recorded for replay purposes. (Operator Instructions)

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

Thank you, Bethany. 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. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, we make no representation or warranty with respect to such information. Earlier today, we issued our earnings release for the second quarter ended June 30, 2022.

We also posted a supplemental earnings presentation to our website at tcpcapital.com. To view the slide presentation, should be viewed in conjunction with the company's Form 10-Q, which was filed with the SEC earlier today.

I will now turn the call over to our Chairman and CEO, Raj Vig.

Thanks, Katie, and thank you all for joining us today for TCPC's Second Quarter 2022 Earnings Call. As usual, I will begin today's call with a few comments on the market environment as well as highlights from our second quarter results. I will then turn the call over to our President and Chief Operating Officer, Phil Tseng, who will provide an update on our portfolio and investment activity. Our CFO, Erik Cuellar, will then review our financial results as well as our capital and liquidity positioning in greater detail. I will then conclude with a few closing remarks before we take your questions. As many of you are aware, the current economic environment is characterized by negative GDP growth, the highest inflation rate in generation and aggressive FED tightening.

Within this environment, direct lending continues to be a reliable source of financing for a wide spectrum of middle-market companies and a reliable source of returns for investors. We have often noted that direct lending has outperformed other segments of the market during periods of instability and we believe that remains the case in the current environment. As a reminder, the assets we invest in are typically senior in the capital structure and underwritten with meaningful lender protections. These often include significant collateral packages and contain real covenants, specifically tailored to each borrower's business and industry. Our strategy has always focused on core middle market businesses in diverse, resilient and less cyclical industries. These companies have historically outperformed their larger corporate counterparts during economic downturns.

For example, during 2007 to 2009, the middle market added 2.2 million jobs while larger businesses actually shed 3.7 million jobs. It seems like we've been living in "unprecedented times for some time now." Prior to 2020, none of us had considered a global pandemic and an economic shutdown in our base case underwriting. Since the initial COVID shock, pandemic and supply chain pressures have contributed to an inflationary environment that many haven't experienced in quite some time or ever for that matter. However, our team's proven ability to identify and invest in businesses that successfully manage periods of economic stress gives us confidence in the resiliency of our approach to direct lending. Regardless of the market environment, we have always been disciplined on our underwriting standards and evaluated a borrower's ability to manage in times address through both a forward-looking view and historical lens of performance through prior periods of stress.

We remain confident in the strength of our diverse portfolio to continue to withstand periods of economic volatility. So what does this all mean for the existing portfolio? I'm very glad to report that the portfolio remains in excellent shape. Clearly, in many sectors, growth is slowing, inflationary pressures, especially for wages, has resulted in a degree of margin erosion, and where applicable, supply chain issues have further pressured earnings. However, we have been pleased with our borrowers of proactive actions to these pressures, including curbing spending and their ability to find cost savings in other parts of their organizations. We have also been able to further validate relatively inelastic demand for their products or services and have observed an ability to pass along cost increases to their end customers. Furthermore, given the floating rate nature of our strategy, interest rate increases are actually a benefit to our portfolio.

And of course, we continue to closely monitor our borrowers' ability to service debt in a rising rate environment. Let's now turn to our second quarter performance and a few highlights from the quarter. First, we delivered solid net investment income of $0.37 per share, which exceeded our second quarter dividend of $0.30 per share. This extends our record of continuous dividend coverage throughout our more than 10 years as a public company. And today, our Board of Directors declared a third quarter 2022 dividend of $0.30 per share, payable on September 30 to shareholders of record on September 16. Second, our portfolio credit quality remained strong. As of June 30, non-accruals were just 0.3% of the portfolio at fair value. Our excellent asset quality is a function of our disciplined and consistent underwriting practices.

And third, as Phil will discuss in more detail, the strength of our underwriting platform continued to drive solid investment opportunities that resulted in a total of $103 million deployed, a total of 9 investments during the second quarter. This is a testament to the strength of the relationships we've developed with a variety of deal sources over our more than 2 decades in direct lending as well as the extensive resources and relationships of the broader BlackRock platform. Sales and repayments during the second quarter totaled $82 million, resulting in net acquisitions of $21 million. During the quarter, we continued to exceed our cumulative total return hurdle. As a reminder, TCPC maintains [surrealized] and unrealized gains and losses and with a cumulative look back. Since 2012, when we took TCPC public, we have generated a 10.7% annualized return on invested assets and a total annualized cash return of 9.4%.

We believe that this is at the high end of our peer group, demonstrating our ability to consistently identify attract our shareholders. NAV did decline 2.1% during the second quarter, primarily as a result of widening market credit spreads, which resulted in net unrealized losses on our existing portfolio. These unrealized losses were partially offset by net investment income in excess of the dividend.

Now I'll turn it over to Phil to discuss our investment activity and portfolio positioning. Phil?

Thanks, Raj. But despite the public market volatility, we continue to capitalize on the scale of our platform as of our investments were senior secured debt, spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. As we previously noted, our portfolio is weighted towards companies with established business models in less cyclical industries. The portfolio at quarter end consisted of investments in 122 companies. As the chart on the left side of Slide 6 of the presentation illustrates, our recurring revenue income is distributed broadly across our portfolio and is not reliant on income from any one company. In fact, more than 90% of the rate environment.

Moving on to our investment activity, as one of a small group of reputable lenders capable of providing complete and customized financing solutions, we focus on transactions where our U.S. private capital team acts as a lead, co-lead or part of a small club of lenders. This enables us to negotiate deal terms and conditions that we believe provide meaningful downside protection on our investments. Robust lender protections, including substantial collateral and tailored covenant packages are particularly important in periods of economic volatility. We have delivered from borrowers and deal sources on over 1,000 transactions across the U.S. private capital platform. Our extensive long-standing relationships provide us an advantage in identifying and assessing investment opportunities in this current environment. In addition, our industry specialization, which our borrowers truly value, bolsters our ability to assess and underwrite risk.

We source an increasingly large set of investment opportunities for multiple channels. And while we have been actively deploying capital in this market, we maintain a very disciplined approach to investing. We regularly review a substantial number of opportunities but only invest in a small fraction of them. General market activity was slower in the first half of 2022 relative to the record levels we saw in 2021 based on M&A and refinancings. However, we actually continue to see strong new deal activity, which allowed us to be highly selective. TCPC invested $103 million in the second quarter, primarily in 9 investments, including loans to 6 new portfolio companies and 3 existing ones. Follow-on investments in existing holdings continue to be important sources of opportunity, accounting for 50% of total dollars invested over the last 12 months.

Incumbency is an important factor in sourcing investment opportunities and we believe that advantage will only increase if economic conditions continue to deteriorate. These are companies we already know and understand well, and therefore, are very comfortable in making follow-on investments. As we analyze new investment opportunities, we emphasize seniority in the capital structure, portfolio diversity and transactions where our U.S. private capital team acts as lead or co-lead. TCPC's largest investment during the second quarter was an incremental first lien term loan to AlphaSense. The company provides AI-based market intelligence to financial services and corporate clients. Our team was selected to provide the financing given our reputation and scale despite offers from other lenders at lower pricing. BlackRock's U.S. Private Capital team acted as the sole lender to refinance AlphaSense's existing debt and subsequently to provide acquisition financing.

We saw this as an attractive opportunity to invest in a company with robust growth and a highly visible revenue stream from an entrenched blue chip customer base. Our second largest investment in the quarter was a first lien term loan and revolver to BCom, a global provider of compensation management software. The sponsor reached out to us directly to provide the acquisition financing and we've served as the sole lender. We view this as an opportunity to lend to an industry leader with a strong value proposition, high-quality retention rates that provide high revenue visibility and a diverse existing client base. As Raj mentioned, new investments in the first quarter were partially offset by dispositions and repayments totaling $82 million as we had several successful exits and paydowns. These included the full repayments of our loans to Kaseya, Puppet and Core Media.

The overall effective yield on our portfolio was 9.8% as of June 30, reflecting the benefit of higher interest rates now that substantially all of our loans are above the floors. Investments in new portfolio companies during the quarter had a weighted average yield of 8.9%, exceeding the 8.8 weighted average effective yield on exited positions. Given that 95% of our debt portfolio is floating rate and the majority of our outstanding liabilities are fixed rate, we are well positioned for further rate increases. We continue to invest selectively maintaining our underwriting discipline and being mindful of the inflationary environment. We focus on companies with established business models that are well positioned to succeed throughout economic cycles. And our pipeline currently is healthy and we're sourcing attractive opportunities across multiple sectors. The yields on investments in our pipeline are generally in line with our current portfolio.

And to date, we have had limited prepayment income in the third quarter. Let me now turn it over to Erik to walk through our financial results as well as our capital and liquidity positioning.

Thank you, Phil. I'll start by turning to our financial results for the second quarter. We generated strong net investment income of $0.37 per share, which exceeded our dividend of $0.30 per share. Investment income benefited in part from the increase in base rates and given the majority of our loans reset quarterly, we expect to see further benefits of the rate increases to date in our third quarter net investment income. We are committed to paying a sustainable dividend that is fully covered by net investment income as we have done consistently over the last 10 years. And today, as Raj noted, we declared a third quarter dividend of $0.30 per share. Investment income for the second quarter was $0.76 per share. This included recurring cash interest of $0.61, recurring discount and fee amortization of $0.04 and PIK income of $0.03. Notably, our PIK income remains near its lowest level in the last 3 years.

Investment income also included $0.05 of dividend income and $0.03 from accelerated OID and exit fees. As a reminder, 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 $0.32 per share and included interest and other debt expenses of $0.16 per share. Incentive fees in the quarter totaled $4.5 million or $0.08 per share. Net realized losses in the second quarter totaled $18.4 million or $0.32 per share and included $13.8 million from the realization of previous unrealized losses on our investment in Fishbowl as a result of the company's restructuring, also $13.3 million from the realization of previous unrealized losses on our investment in Avanti. These were partially offset by an $11 million gain from the exit of our investment in core entertainment.

Net unrealized losses totaled $3 million and were primarily driven by widening market spreads, which had a negative impact on the mark-to-market of our existing portfolio. The impact of wider spreads was partially offset by a $6.7 million unrealized gain on our investment in Edmentum, as well as the reversal of the previously recognized unrealized losses on Fishbowl and Avanti. The net increase in net assets for the quarter was $128,000 or less than $0.01 per share. Substantially, all of our investments are valued every quarter using prices provided by independent third-party sources. These include quotation services and independent valuation services. And our process is also subject to rigorous oversight, including back testing of every disposition against our valuations. Our credit quality remains strong with non-accrual loans at quarter end, limited to only 2 portfolio companies that represent just 30 basis points of the portfolio at fair value and 50 basis points at cost.

Now turning to our liquidity, we ended the quarter with total liquidity of $237 million relative to our total investments of $1.8 billion. This included available leverage of $187 million and cash of $49 million. Unfunded loan commitments to portfolio companies at quarter end equaled 8% of total investments for approximately $142 million, of which only $25 million were revolver commitments. Our diverse and flexible leverage program includes 2 low-cost credit facilities, 2 unsecured novations and an SBA program. And our unsecured debt continues to be investment-grade rated by both Moody's and Fitch. Given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing, and our maturities remain well laddered.

Additionally, due in part to the opportunistic add-on bond issuance that we executed in August of last year, when we took advantage of an attractive financing environment at the time, we are comfortable with our current mix of secured and unsecured financing and do not have any immediate financing needs. Combined, the weighted average interest rate on our outstanding borrowings decreased to 3.9% from 3.26% at the end of 2021.

Now I'll turn the call back over to Raj.

Thanks, Erik. To conclude, we delivered another strong quarter of results and are confident in our team's ability to generate attractive ongoing risk-adjusted returns for our shareholders in this complex and evolving environment. Volatility and uncertainty in the public markets this year has been driven by inflation concerns and geopolitical instability. In periods of economic uncertainty, we are reminded of the benefits of private credit, which has historically performed well throughout economic cycles.

To reiterate, our loans are typically at the top of the capital stack, often with collateral protections and with significant equity and/or subordinated capital structured below our investments. Additionally, we structure our loans with meaningful financial and maintenance covenants, and our portfolio remains well diversified by issuer and industry. It is in periods of market volatility that the strength of our diversified strategy and depth of our team's experience is a particular advantage. Our investment team's expertise consists of performing direct lending and special situations investing. This combination of investing experience in addition to our focus on transactions where BlackRock either leads or co-lead negotiations on deal terms ensure that we structure loans that are priced appropriately and include adequate downside protection, which has contributed to our team's exceptional long-term performance.

And with that, operator, please open the call for questions.

(Operator Instructions) Our first question is from the line of Kevin Fultz with JMP Securities.

I'd like to start by asking about your thoughts around maintaining the level of the dividend at $0.30 per share. Obviously, over the past 2 quarters, you've easily covered the dividend and with an outlook for rising base rates, driving further net investment income acceleration, it would appear that a dividend increase could be supported? Just curious if you could share some high-level thoughts about how you're thinking about things there?

Yes. Kevin, thank you for the question. And by no means is that a surprise, I think, in the current environment. I would say, as we said in the past calls, our focus is to maintain a well-covered and stable dividend, one that has a lot of protection and visibility. I think the environment, certainly for the marginal dollar, has more return to it but when you bifurcate that, a lot of that return is coming through rates, increase in rates that we've seen benefit from and just the operating leverage in the portfolio. If you kind of make your way through the onetime benefits and just the run rate of the portfolio, it's higher, it's roughly $0.32 but when we think about any change in the dividend, we really need to make sure that the components that are driving that higher dividend and coverage of it are more visible and stable.

And I think for the current quarter, it was just too early to determine if that was the case. And we're continuing to assess it as we do every quarter with the Board and just kind of making our way through the portfolio and just environmental components. So it's certainly a timely and relevant question. I think it doesn't change our operating philosophy of what we think is valued in a dividend, which is a stable and covered dividend. And as we kind of get our hands around the components that drive a stable and covered dividend, I think we're going to continue to assess it within the context of the environment and our outlook. Hopefully, that helps give you some clarity.

And then just one follow-up, if I can. Originations were understandably on the lighter side in the second quarter given the slowdown in M&A activity and macro uncertainty but it appears you're able to find some tax opportunities still. Can you provide some commentary around expectations for the deal environment and then also net origination activity levels for the back half of the year?

Yes, we do continue to expect healthy originations of volumes. We're by no means a proxy for the broader private credit market. So understanding that there's been a general slowdown in M&A refinancing activity, in particular, we're seeing a little bit different of a trend for us, which is, we continue to be selective, we continue to play deeply in the industries that we like and we expect that to continue in the next 2 quarters. We have deep relationships pretty entrenched in a lot of the sectors we play. We're often being asked to step in early on a lot of these processes as buyers looking for financing certainty as part of being able to deliver solid bids themselves and with the help of BlackRock's broader sourcing platform, it only continues to enhance what we do.

Our next question comes from the line of Ryan Lynch with KBW.

My first question I had, you guys talked about benefiting from rising rates. Obviously, there was a big move in the second quarter, which doesn't really flow through as loans reset probably until the third quarter. So I'm not sure if you run this math or not, but could you help quantify what you think that the benefit from rising rates will be in the third quarter over what it was in the second quarter to kind of give us a sense of what that impact is?

Yes, Ryan, this is Erik. Thanks for the question. We do expect to see that flow through even more so in Q3. And as you mentioned, not completely all of the rate increases because of the lag when they do reset. The table that we presented in the Q end of the presentation kind of gives you a rough idea. If we were to see the full benefit run through in any single quarter, it could be up to $0.05 per quarter. Again, we expect to see a partial benefit from that, so probably more in the range of $0.02 to $0.03 of incremental income for the quarter.

And the other question I had, I was hoping you could provide some more color on your investment in JUUL. There's been some recent news out there where Altria has written their investment down significantly. I think it's written down by 95 plus percent from their original investment. They just wrote it down significantly a couple of weeks ago, that investment, the product out banned by the FDA for a minute there, they got reopened and they're looking at that as we will do that application closer. So I'm just curious, I know you're in a first lien position in that capital structure but with the equity getting worth closer and closer to 0, it seems like every few quarters, is there any capital that's subbed your first lien? Is there any sub debt or second lien there or is the capital stack basically the equity and then your first lien position?

Yes, I can take that one. And certainly, this one has a lot of headlines to it. And as you can imagine, because of that, we're a little cautious in what we can and can't say, just anticipating a lot of discussion outside of our position. But I would say that just to be clear, just to be specific, the FDA's actions were subject to a stay order in July, so that shutdown essentially was stayed by the courts. But I think overall, and to answer your question, there is junior capital below our first lien.

And even with the write-down, I think the convertible bonds and then the equity itself still has value, it's just obviously not the value that the last investments were made in. But regardless, being in the first end, our sense is and our view is generally that our thesis is intact at that level, even with the headlines and some of the volatility around the name. I think we're cautious to comment beyond that other than saying, we're in the first, we're comfortable in that position, there is junior capital beneath us and what happens in the public eye will probably continue to have headline elements to it but where we are, we feel comfortable.

Our next question comes from the line of Robert Dodd with Raymond James.

Congrats on the quarter. First, a housekeeping one, then I've got a couple of others. On the dividend income, which was quite strong this quarter, is that a recurring level or was there any onetime dividend income in this quarter?

Robert, this is Erik. We do have a level of recurring dividend income, which has been approximately $0.03 per quarter and we do view that as recurring. This quarter, we did get, approximately, a little over $0.02 of what we would consider non-recurring dividend income from 36th Street, which has continued to perform very well and just made an incremental distribution this quarter.

There was a comment earlier, I can't remember you actually had, talking about the pipeline, the yields are generally in line with the rest of the portfolio. I mean is that what are you seeing on pricing? I mean if the pipeline is generally in line, is that an indication that in the incumbent positions you're in, et cetera, et cetera? Are you not seeing any spread widening on opportunities in pipeline right now? And is that true or do you expect to see any spread widening in this environment right now?

Yes. I'll take that, Robert, and Phil may have additional comments but I think it's a more nuanced answer, I would say, and it's part of the reason we like prime credit. From a total return point of view, there's numerous ways to get return, right. And so we are seeing spreads at least stable and to be honest, in cases, widening at the marginal dollar, our target returns and kind of hurdle rates as we make decisions for new investments has gone up. The big chunk of the return increase thus far has been through the reference rate. It's mostly SOFR now versus LIBOR, that has seen a lot of uptick and you've seen that partially flowing through the portfolio and that will continue at these levels. But also the things that don't necessarily emerge upon the current yield, partly, it's the OID widening.

And as a reminder, we don't take that all up front, we amortize it. And also prepayment structures, we now have more ability to push back and see those become a little more favorable, which you won't get until the back end as those trigger. So I think the net-net of it is, the pipeline is good, the pricing environment is better. The bulk of it thus far has been through the reference rate and as we see discussions with borrowers continue, the ability to sort of push back or at least keep spreads at an interesting level and even wider for total return targets that are higher is all kind of relevant today. Some will emerge upon the close of the deal, some will emerge over the life of the deal and some will come at the back end but I think your intuition around it being a better environment from that perspective is spot on, I would say.

Sorry, Robert, this is Phil. I'll just add that we're in the risk/reward assessment business and it's not only about the reward. So we are using this environment to, maybe if we're not pushing on price necessarily, we're certainly pushing on elements of risk. So looking to negotiate whether it's better structures, i.e., lower leverage, I think maybe tighter covenants, maybe other credit documentation enhancements. We're really using the environment to not just focus on pushing price, which, of course, we're always looking to enhance our yields but also for downside protection to manage risk.

It's definitely a risk-reward business. It's not just a reward business. Last one, if I can. I saw in the press release, I think the manager has been put in as a valuation [desime]. Can you tell us what that means in a practical sense?

Sure, Robert. What it doesn't mean is that there's any change in the validation process at all. Really, historically, the Board has been the one approving the valuations and with the adviser performing substantially all of the valuation procedures, now this just formalizes the process by which the adviser continues to fulfill the valuation policies and procedures. So no real change in any of the evaluation processes.

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

Fishball, that's now a controlled company. And what sort of business is it, a restaurant business or a hotel? I mean, a little color around what it is?

Yes. Sure. So Fishball, it's been renamed to Personica recently. It's a software platform for restaurants. So they enhance marketing solutions for most of the quick service side of the restaurant industry, severely impacted, as we've discussed in the past, by COVID, with the shutdowns and also experienced management turnover. So at this point, we have gone through the recapitalization of that business, so we co-own the business with the sponsor, which I would note, as part of that process infuse additional capital onto the balance sheet as well as some to pay down the debt at par. Challenges certainly remain with this credit but we're optimistic given the implementation of a new CEO recently with restaurant technologies and expertise. And so we feel like we're better positioned now, especially from a capital structure and management perspective, to achieve our growth objectives.

There are no additional questions waiting at this time. I would like to pass the conference back to Raj Vig for any closing remarks.

Thank you, operator. We appreciate your participation on today's call. I would like to thank our team for all the continued hard work and dedication. I would also like to thank our shareholders and capital partners for their confidence and their continued support. Thanks for joining us. This concludes today's call.

That concludes the BlackRock TCP Capital Corp. Second Quarter 2022 Earnings Conference Call. I hope you all enjoy the rest of your day.