BlackRock TCP Capital Corp (TCPC) 2022 Q3 法說會逐字稿

Ladies and gentlemen, good afternoon. Welcome, everyone, to BlackRock TCP Capital Corp.'s Third Quarter 2021 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 Katy McGlynn, Director of the BlackRock TCP Capital Corp. Investor Relations team. Katie, please proceed.

Thank you, [Tamiya 0:00:37]. Before we begin, all 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 third quarter ended September 30, 2022. We also posted a supplemental earnings presentation to our website at www.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. These documents should be reviewed 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 Third 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 third 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 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.

The third quarter closed with a continuation of the public market turbulence we have seen across global financial markets this year. It isn't often that both equity and bond markets trade negatively in the same year. However, a combination of geopolitical uncertainty and central banks move to raise interest rates to curb the highest levels of inflation in more than 40 years is driving significant volatility. In this environment, direct lending continues to provide a strong value proposition for both investors and borrowers in terms of safer, visible returns and availability of capital solutions, respectively.

While we are increasingly cautious in this environment, we take comfort in the fact that the investments in our portfolio are structurally senior. Our loans are primarily first lien and are underwritten with meaningful covenants that provide us with an avenue to constructively engage with our borrowers as challenges are foreseen. This proactive approach, combined with structural seniority are hallmarks of our strategy and long-standing commitment to strong product quality and principal protection. Our strategy has always focused on core middle market businesses in diverse, resilient and less cyclical industries.

Although large public companies are often perceived to be less risky, the middle market has historically proved to be nimble and resilient during economic downturns. To date, we are seeing our portfolio companies take actions to address the more challenging market environment. We are observing companies reduced marketing budgets and other discretionary spending. Certain companies are also raising capital where needed and focusing on acquisitions that continue to drive scale and reduce costs.

Turning to our portfolio. We continuously monitor all of our investments and are actively doing so in this environment. While we are seeing some margin pressure as a result of the inflationary environment and a generally tempered growth outlook, we are very comfortable with our typical position as a senior secured lender and believe our loans are very well covered. We are also seeing a general ability to pass along cost increases to end customers given inelastic demand for our portfolio companies products and services.

Regardless of the market environment, we have always been disciplined with our underwriting standards. We evaluate each borrower's ability to manage (inaudible) through both its forward-looking and a historical lens of performance through prior periods of stress or dislocation. Ultimately, we have confidence in our underwriting, our team and the strength of our diverse portfolio to continue to withstand periods of economic volatility.

Let's now turn to our third quarter performance and a few highlights from the quarter. First, we delivered strong net investment income of $0.42 per share. Given the floating rate nature of our portfolio, our net investment income continues to benefit from the increase in base rates through this year. Our net investment income again exceeded our third quarter dividend of $0.30 per share, and we are pleased to announce today our Board of Directors declared a fourth quarter dividend of $0.32 per share, an increase of $0.02 payable on December 30 to shareholders of record on December 16. We have always emphasized the stability of the dividend and coverage through our recurring net investment income. And our Board's decision to increase the dividend is an acknowledgment of the increase in the ongoing earnings power of the portfolio and confidence in maintaining our continuous track record of dividend coverage.

Second, NAV increased 1.1% during the quarter, driven by net unrealized gains in the portfolio and net investment income in excess of the dividend. Net unrealized gains were primarily driven by an increase in the value of our investment in 36th Street and partially offset by decreases in the value of our investments in AutoAlert and Securus as well as the impact of wider market spreads across the portfolio.

Third, our portfolio credit quality remained strong, and we had no new non‐accruals in the quarter. As of September 30, non‐accruals were just 0.3% of the portfolio at fair value. Our excellent asset quality is both a function of our disciplined and consistent underwriting practices and our vigilant credit monitoring.

Fourth, and as Phil will discuss in more detail, the strength of our underwriting platform continue to drive solid investment opportunities that resulted in a total of 17 new investments totaling $48 million. We also had several prepayments that occurred at the end of the quarter, including th full prepayments (inaudible) --. As a result, repayments during the third quarter totaled $170 million, resulting in net dispositions of $122 million. Finally, we are excited to welcome Karen Leets to TCP's Board of Directors, expanding our Board to 7 members, including 6 independent directors. Karyn is a Senior Vice President and Treasurer of Baxter International, a multinational health care company, and she brings a distinguished background and a wealth of Gartner's experience that will further strengthen our Board on behalf of shareholders.

TCPC continues to deliver strong results for shareholders. Our total return remains above our cumulative total return hurdle. As a reminder, TCPC maintains a 7% hurdle rate based on total returns, including realized and unrealized gains and losses on both the income and capital gains component of the incentive fee with a cumulative look back. Since 2012, when we took TCPC public, we have generated a 10.7% annualized return on invested assets, a total annualized cash return of 9.4%, demonstrating our ability to consistently identify attractive opportunities of premium yields and deliver strong and consistent returns to our shareholders across market cycles.

Now I will turn it over to Phil to discuss our investment activity and portfolio positioning.

Thanks, Raj. Despite the public market volatility that is driving uncertainty in the capital markets, we continue to capitalize on the scale of the broader BlackRock U.S. Private Capital platform and breadth from our team's experience to identify attractive investment opportunities in this environment. At quarter end, our portfolio had a fair market value of approximately $1.7 billion. 87% 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 132 companies; an all-time high for this portfolio. As the chart on the left side of Slide 6 of the presentation illustrates, our recurring income is distributed broadly across our portfolio and is not reliant on income from any one company. In fact, more than 90% of our portfolio companies each contribute less than 2% to our recurring income. 84% of our debt investments are first lien, providing significant downside protection and 95% of our debt investments are floating rate, providing an important benefit in this rise rate environment.

Moving on to our investment activity. As one of the 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 partner small club of lenders. This enabled us to negotiate bill terms and conditions that we believe provide meaningful downside protection. These include substantial collateral and tailored covenant packages that are important, especially in periods of economic volatility like we are in today and expect to be in for the foreseeable future.

In addition, our industry specialization, which our borrowers value, bolsters our ability to assess and effectively mitigate risk in our underwriting and when negotiating terms in the credit documents. We have delivered for borrowers and deal sources on over 1,000 transactions across the U.S. Private Capital platform through our more than 2 decades of lending to middle market companies. Our long-standing relationships cultivated over those 2 decades, coupled with the power of BlackRock platform, provide us with an advantage of sourcing and identifying attractive investment opportunities.

We also believe that our ability to source from multiple channels and our ability to lend a unique or less understood situations are benefiting our pipeline of investment opportunities in the current environment. While we have been actively deploying capital in this market, we maintain a very disciplined approach to investing.

General market activity has slowed relative to the record levels of 2021. However, we continue to see strong new deal activity in areas such as add-on acquisitions and opportunities from nonsponsor deal sources. TCPC invested $48 million in the third quarter, primarily in 17 investments, including loans to 14 new portfolio companies and 3 existing ones. In terms of dollars invested, 60% of total investments in the third quarter came from our existing portfolio companies.

Follow-on investments in existing holdings continue to be an important source of opportunity, accounting for nearly 50% of total dollars deployed over the last 12 months. We believe this incumbency is an important advantage in sourcing investments that will only increase if economic conditions deteriorate further. These are companies we already know well and understand well and therefore, are comfortable making these follow-on investments.

TCPC's largest investment during the third quarter was a senior secured first lien term loan to Achieve. Achieve is a founder-led personal finance company that helps consumers overcome and reduce outstanding debt burdens. Given the complexity of the transaction and our team's experience lending to financial services companies, our team was selected to lead this transaction. And this financing will be used to pay down existing debt and support achieved growth initiatives.

Our second largest investment in the quarter was a senior secured first lien term loan to Anaconda, with over 29 million active users, including more than 700 enterprise customers. Anaconda is a scaled global data science and machine learning platform. BlackRock served as the sole vendor on this transaction, which will go towards refinancing existing debt as well as to fund Anaconda's growth. As Raj mentioned, new investments in the third quarter were offset by several meaningful payoffs, including Dude Solutions, Foursquare, JUUL, and Metricstream. In light of the challenges JUUL continues to face, we are thrilled and we're able to opportunistically exit our loan at par.

Total dispositions and repayments totaled $170 million. The overall effective yield on our debt portfolio rose meaningfully from 9.8% as of June 30 to 11.3%, reflecting the benefit of higher rates during this quarter. Importantly, the full benefit of rates in effect at September 30 will be reflected in our fourth quarter results, given the majority of our loans reset quarterly. Investments in new portfolio companies during the quarter had a weighted average effective yield of 11.3%, exceeding the 9.9% weighted average yield on exit positions.

Although the private markets tend to be slower to react to changes in the market environment, we are seeing a shift toward a more lender-friendly environment with improvements in pricing and terms relative to 6 to 9 months ago. We continue to invest selectively, maintaining our underwriting discipline and being mindful of this inflationary environment. We focus on companies with established business models that are well positioned to succeed throughout economic cycles, and we emphasize the companies that have significant pricing power to pass on increasing input costs, including the cost of capital.

It's also important to note that we do not underwrite to perfection, but build in sufficient buffer to ensure companies can withstand higher cost and changes in the market environment without impairing their ability to service our loans. While we're seeing a slowdown in deal activity relative to the flurry of deals we saw in the fourth quarter of last year, our pipeline remains healthy. 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 fourth quarter.

I'll now turn it over to Erik to walk through our financial results as well as our capital and liquidity positioning.

Thank you, Phil. As Raj noted, our net investment income in the third quarter benefited from the increase in base rate so far this year as well as $0.06 of repayment income. Net investment income of $0.42 was up 14% from the second quarter and more than 30% from 1 year ago. Net investment income again exceeded our second quarter dividend of $0.30 per share. We're committed to paying a sustainable dividend that is fully covered by net investment income as we have done consistently over the last 10-plus years.

Today, as Raj noted, we declared a fourth quarter dividend of $0.32 per share, increasing our dividend by $0.02 per share. Investment income for the third quarter was $0.83 per share. This included recurring cash interest of $0.67, recurring discount and fee amortization of $0.03 and PIK income of $0.03. Notably, our PIK income remains lower than our historical average. Investment income also included $0.03 of dividend income, $0.01 of other income and $0.06 from accelerated O&D and XFP.

As a reminder, we amortized upfront economics of the life fund investment rather than recognizing all of it at the time the investment is made. Operating expenses for the third quarter were $0.32 per share and included interest and other debt expenses of $0.18 per share. Incentive fees in the quarter totaled $5.2 million or $0.09 per share.

Net realized and unrealized gains in the third quarter totaled $1.8 million or $0.03 per share and were driven primarily by $1.6 million of net unrealized gains on the portfolio. These net unrealized gains in the third quarter included an $18.8 million increase in the value of our investment in (inaudible). Unrealized gains in the third quarter also included a $3.3 million reversal of prior unrealized losses on our investment in JUUL as we exited our investment on par during the third quarter.

Unrealized gains were partially offset by a $5.9 million decrease in the value of our investment in (inaudible), and a $2 million mark-to-market decline in the value of our Aventa Technology as well as the impact of wider market spreads across our portfolio. The net increase in net assets for the quarter was $26.2 million or $0.45 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 this process is also subject to rigorous oversight, including back testing of every disposition against our valuations. Our credit quality remained strong with non-accrual loans at quarter end limited to 2 portfolio companies that represent just 30 basis points of the portfolio at fair value and 50 basis points at costs.

Before turning to our liquidity, a quick comment on our fourth quarter earnings expectations. While we don't provide forward-looking guidance, it is important to note that our third quarter NII benefited from $0.06 of nonrecurring items. Additionally, while we expect to further benefit from the increase in base rates, we also had a significant amount of pay downs that occurred at the end of the third quarter that reduced leverage and the size of our portfolio going into the fourth quarter.

Turning to our liquidity. We ended the quarter with total liquidity of $351 million relative to our total investments of $1.7 billion. This included available leverage of $246 million and cash of $106 million. Unfunded loan commitments to portfolio companies at quarter end equaled 7% of total investments or approximately $124 million, of which only $20 million were revolver commitments.

Our diverse and flexible leverage program includes 2 low-cost credit facilities, 2 unsecured note issuances, and an SBA program. Notably, our unsecured debt continues to be investment-grade rated by both WES 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 be opportunistic add-on (inaudible) that we executed in the second half of last year in which we took advantage of the attractive financing environment at the time, we are comfortable with our current mix of secured and unsecured financing and do not have any major financing needs. Also, given our higher percentage of fixed rate borrowings, the combined weighted average interest rate on our outstanding borrowings increased only modestly to 3.41% from 3.26% at the end of 2021.

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

Thanks, Eric. Despite volatility in the broader markets, we are leveraging the power and comprehensives of the BlackRock platform and our team's deep experience to selectively deploy capital on favorable terms. Our liquidity is strong, and we have ample dry powder to deploy incremental capital where we see the opportunity. Our investment team's breadth of expertise consists of performing direct lending and special situations investing, a combination that is particularly well suited for the current environment.

While we remain disciplined in our investment approach and focus on credit quality, we have been able to continually build and diversify the portfolio. The consistency of our performance demonstrates both the efforts of our experienced team and the value of our risk-reward proposition.

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

(Operator Instructions) The first question comes from Kevin Fultz with JMP Securities.

Good morning and congratulations on a really nice quarter. My first question, if I get off from Level 1, on your deal selectivity rate and deal volume, could you remind me what your historical average deal selectivity rate is and how that has trended recently? And then secondly, could you give us an idea on the total dollar value or number of deals you review on an annual basis?

Yes, sure. Thanks for the question, Kevin. This is Phil. So our selectivity rate generally ranges anywhere between 4% to 6% on any given year, and that's consistent with the current environment. So we'll evaluate anywhere between 1,000 to 1,200 deals a year on average. And our pipeline today continues to be healthy. It's not quite as robust as you can imagine versus, let's say, 12 months ago, given the environment around refinancing and M&A generally.

But for us, it doesn't take a lot for us to stay busy. We have quite a wide funnel and we always achieved to do so. Based on our sources of deals, it's a very wide set of channels, not just sponsor but also very much focused on a non-sponsor channel where we find [role-pricing] founder or family-owned businesses that make for fantastic credits.

But it's also important to keep mind that quite a number of our pipeline opportunities come through our -- sorry, come through our existing portfolio. This past quarter happened to be quite high, roughly 60%. But generally, anywhere between 40% to 50% comes from our existing portfolio, which is certainly deal flow that we like because we know those businesses well. We have a great relationship with management. We've seen management execute. And if we're comfortable, then that's putting good money after good portfolio companies.

And then my follow-up is around how you're thinking about leverage in the current environment. I realize you had some sizable repayments during the quarter. On the other side, origination activity was fairly light. So I'm curious if that was intentional deleveraging of the portfolio or more so driven by the attractiveness of investment opportunities that you're seeing in the market.

Yes. Kevin, this is Eric. I'll take that. In terms of the pace of the repayments, that's probably the one factor that's hardest to predict. But as I mentioned, it was elevated during Q3. In terms of the leverage level, we're comfortable that if the portfolio shrink. Having said that, it is lower than it's been over the last few quarters. We like that it gives us the flexibility to deploy if we see attractive opportunities.

Our next question comes from Ryan Lynch with KBW.

First question I had, you mentioned the $19 million unrealized gain on 36th Street Capital. I'd love to just hear what drove that increase in that valuation.

Thanks for the question. It was 2 factors really. And again, just a reminder that all of this is through third parties. One is the group has just been performing, and the investment very well, and we're very pleased with that. That also accreted to a better multiple relative to the comps from the valuation providers. They get more credit just because they're performing and the consistency of that performance. As part of it, there's also a benefit based on some pending strategic initiatives that are at the company level. And we hope to have more detail to talk to you about that with clarity soon, hopefully, next quarter. But it was a combination of just current market valuation and also the company-specific strategic benefits.

Okay. And then the other one I had was, what is your current weighted average interest coverage on your portfolio? And how has that trended, let's say, over the last 6 months?

Yes. I think it's strong. We don't really necessarily give specific numbers because there's a lot of variances in the portfolio that can make an average a little misleading. But I would say on the cash flow coverage on our portfolio, it's roughly 2.5x and has trended up. Part of that is where we have covenants, many of them will have step downs that require people to -- in the case of a coverage ratio, step-ups that will require people to have credit improvement. And also, to the extent these are companies, even if they're growing slower, they're still growing or we're stabilizing and seeing a benefit of deleveraging that accretes to the coverage.

Obviously, the part of the offset is the rate increase. But the number of applicable to cash flow coverage is roughly in the 2.5x time range.

And then my final question was just on dividend and dividend coverage. You guys obviously raised the dividend this quarter -- or excuse me, for the upcoming fourth quarter. If I look at that coverage relative to Q3 earnings, which you did say there were a couple of one-time items, there was $0.06 of kind of accelerated prepayments versus maybe $0.03 in the last quarter. So that has kind of helped third quarter earnings as well as some late quarter repayments, which could pressure earnings.

You still had about over 130% dividend coverage, which feels extremely high. So can you walk through the thought process of the dividend increase and how you chose the level that you increased it to? And where do you guys want to be running at from a dividend coverage standpoint? Because I still think there's a lot of room based on the current trajectory (inaudible) where the dividend is set at.

Let me try and provide some color. There's no signs to it. And I think, first and foremost, we have stated very clearly that we believe it's important to maintain a stable and well-covered dividend. The factors that have been driving the dividend increase through this year are obviously reference rate [SOFR] in most cases, increases that have been playing through on a quarterly basis and will continue to play through.

We don't know where SOFR goes, we know that we benefit as it increases. It feels like it's -- maybe there's more room or it's not coming down necessarily rapidly, but we're not prognosticators on rate. At the same time, we are now seeing, as we invest the marginal dollar, the best set of investing in higher returning investments, including some spread benefits being more stable, if not increasing.

So I think we tried -- and then the third thing, obviously, is just the environment. We're very cautious. We're pleased that we have chosen to stay very defensive, both by industry and by structure coming into this environment. I think we've always been cautious but are increasingly so. And so to the extent there's a view that this is lower for longer, there is just an importance of having continued buffer to provide that strong and stable and well-covered dividend, even though at the moment, there might be some additional room.

I think we would rather take it up and have confidence that it's well covered and stable, and then continue to reassess as the environment clarifies, then do something that requires a reversal or puts pressure on our coverage and our shareholders view of the confidence in our dividend level. I think we took all that into account at a healthy discussion in our board and came to conclusion that the $0.02 was a good raise for this quarter, maybe to start, but at the current environment with fields that we're sticking to our sort of our template in our thinking of how we want to level set and provide dividend and benefits to shareholders.

Okay. Fair enough on that discussion. That's all my questions I had, nice quarter, and congrats on the exit of JUUL.

(Operator Instructions) The next comes from Robert Dodd with Raymond James.

Just going back to kind of the leverage question. I mean, obviously, you've got available liquidity, available capital now. You're saying terms and structures do seem to be moving in a more lender-friendly direction and the pipeline is a little bit more maybe modest today, certainly than it was a year ago. How do you feel -- how should we expect you to kind of utilize that available liquidity? I mean, obviously, you'll be opportunistic, but are you going to be a little bit more content to wait, to hold that? Little leverage in this environment is not a bad thing, especially with rates helping earnings anyway.

Or are you expecting to leverage back up in the relatively near term or maybe wait and take opportunities, take advantage of maybe even more lender-friendly terms at some point?

Yes. So good question. I'll try to provide a little more color. I think part of it, just to keep in mind is the level and the timing of the paydown was pretty back-end loaded, including essentially the last day of the quarter. So there was an impact that just given the cadence of a typical deal doesn't -- it's much quicker to have a pay down than to redeploy into the right types of deals. And so there's just a processing the new capital cadence and timing.

That said, it is great to have capital and available capital to invest in this environment. We're seeing a lot of good opportunities. And so part of it, I think the answer is partly a bit of both. We would expect to utilize the available leverage to do what we think are very attractive deals with maintaining defensive stance in the industries and the structures that we have worked thus far through other market environments. Whether we decide to maintain some buffer as we approach really the rating guidelines is a function of both, those guidelines that we have to stay on top of and also our view that we don't need to stretch in any fashion because the returns are quite compelling, even at this level. But the additional benefits from leverage is something that we anticipate we'll be able to utilize.

So I think it will be a balancing act. I don't think there's any hard and fast target. We expect it to go up just because it came down so quickly at the end of the quarter, and we expect that there will be an additional benefit for the re-leveraging to the extent -- to the level that we're comfortable with as the environment dictates with a clear cap on not exceeding any investment-grade thresholds as those thresholds, whether they move around or not, TBD.

And that's exactly the -- have you received any indications maybe from the rating agencies of the -- and I'm not necessarily just talking about you, obviously, there would be an industry kind of indications about them wanting to see lower leverage at this point in the cycle in order to maintain. Obviously, you want to keep the investment grade rating, and I expect you will. But has that been -- has there been any preliminary feedback from the rating agencies about concern in that regard?

There hasn't to our knowledge or in our case, I don't want to speak for others, but -- and I don't say that with any implication that that's been a message was conveyed. But again, we're in sort of a new environment. I think we're just trying to be cognizant and as informed as we need to be. But to answer your question, no, there hasn't been any feedback on that.

Robert, they recently issued a report on the sector and they didn't change any other limits. Having said that, normally, they look at longer-term changes in the environment before they change those limits.

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

How much spillover income do you guys have?

It's significant. It is about $1.17 on a cumulative basis, $1.17 per share. But that's on a book basis, on a tax basis, it's significantly less given the tax treatment, primarily on prepayment income, which gets capital treatment for tax purposes versus ordinary on a (inaudible) basis.

And I guess a general question. Last quarter, we're talking about the effect of the supply chain constraints and so forth. Any update to that? I mean are you seeing -- are your companies seeing better supply chain? Or is it still the same issues as before? And that's it for me.

Yes. Thanks for the question. I think last quarter, the commentary was around acknowledging that there are supply chain issues broadly speaking. However, given our focus at an industry level, on a company level, it's less relevant for our portfolio. It's something we have to be aware of and monitor in a broader context. But we're really investing for the most part, in asset-light, high IP, high gross margin type cash flow businesses. So it's less of something we see in the portfolio, but something that we observe in the market, just to be clear.

Thank you. There appear to be no further questions in the queue. So I will now pass it back to Raj Vig.

Thank you. 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, our capital partners and our business partners for their confidence and their continued support. Thanks for joining us. This concludes today's call.

This concludes the conference call. Thank you for your participation. You may now disconnect your lines.