ArrowMark Financial Corp. (BANX) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the StoneCastle Financial Corporation’s Second Quarter 2015 Investor Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. Now, I would like to turn the call over to Rachel Schatten, General Counsel of StoneCastle Financial. Thank you, Rachel, you may now begin.

Good afternoon. Before I begin this conference call, we’d like to remind the audience that certain statements made during the call may be considered forward-looking statements based on current management expectations that involve substantial risks and uncertainties. Actual results may differ materially from the results stated in or implied by these forward-looking statements. This would depend on numerous factors such as changes in securities or financial markets or general economic conditions, the volume of sales and purchases of shares of common stock, the continuation of investment advisory, administrative and service contracts, and other risks discussed from time to time in the company’s filings with the SEC including annual and semiannual reports of the company. StoneCastle Financial has based the forward-looking statements included in this presentation on information available to us as of June 30, 2015. The company undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of today, August 13, 2015. Thank you. Now, I will turn the call over to StoneCastle Financial’s Chairman and Chief Executive Officer, Josh Siegel.

Thank you, Rachel. Good afternoon, everyone, and welcome to StoneCastle Financial’s second quarter 2015 investor call. In addition to Rachel, joining me today are George Shilowitz, President; and Pat Farrell, Chief Financial Officer. On the call today, I will highlight StoneCastle Financial’s quarterly results, review the current portfolio and comment briefly on the company’s intra-quarter SEC filing. As always, Pat, will follow with details on our financial results. I am pleased to report that in the second quarter, we delivered increases in four key measurements: total earnings, net investment income, realized capital gains, and an increase in the company’s net asset value. Specifically, in the second quarter, the company reported total earnings of approximately $3.4 million or $0.52 per share, consisting of net investment income and net realized gains. Net investment income for the quarter reached $2.3 million or $0.36 per share, a 26% increase over our results in the first quarter. In addition, the company realized capital gains of approximately $1 million, or $0.16 per share, primarily due to our investment thesis on MMCapS fixed rate mezzanine notes unfolding as planned. We projected at a stress bank inside MMCapS would improve and become current on its deferred [ph] and trust-preferred security. A significant pay down of MMCapS fixed rate mezzanine notes occur during the quarter. At quarter end, the company’s net asset value was $22.05, an increase of $0.15 from the last quarter. Pat will provide additional financial details later in the call. Now, let me spend a few minutes on capital deployment and continue the asset deployment strategies. During the quarter, the company deployed $24 million in 4 investments, as we continue to build a portfolio focused on credit quality and predictable recurring income. In addition, as we noted on our last call, our team has been working on a strategic initiative to invest in a pooled bank credit transaction. As many of you know, when I worked at Salomon Brothers, I focused in part on developing new products, including collateralized pooled investment strategies for the community bank sector. StoneCastle Advisors the affiliate of StoneCastle Asset Management has managed pooled bank investment vehicle of this type for over 11 years, and currently manages over $1.8 billion in pooled transactions. Therefore, our advisor’s organization is a great deal of experience in this area. Utilizing this experienced, StoneCastle Financial is currently considering an investment in the preferred equity of a collateralized pool of bank and bank holding company issued loans, which our advisor believes has the potential to meaningfully increase the company’s portfolio income. There is no guarantee that this transaction will occur and if it does, when it would close? Now, I will provide a brief overview of our portfolio investments. As of June 30, the company had total assets of $193 million, consisting of total investments of $186.3 million, cash of $4 million, and other assets of $2.7 million. Other assets include interest and dividend receivable of $1.8 million and prepaid assets of $0.9 million. Total investments were comprised of 26.6% term loans and debt securities, 25.8% trust-preferred securities, and 38.4% preferred and convertible preferred stock. The balance of 9.2% includes equity positions, short-term investments, and other securities. More portfolio detail can be found in the semiannual N-CSR, which was filed today. Now, I’d like to spend a moment describing three key points that differentiates StoneCastle Financial from other income investment vehicles. First, we use less leverage in certain other investments vehicles, such as BDCs and REITs. We are limited to leverage a 33.3% of total assets, and such limit applies to all 1940 Act registered investment companies. Second, while other vehicles are more highly leveraged, they also often use overnight borrowing, which carries more risk. StoneCastle Financial has a multi-year committed revolving line of credit, while more expensive than overnight debt. We have chosen to reduce the risk of borrowing short-term to buy long-term assets. Lastly, nearly 75% of our investments are deemed investment grade, BBB or better by Crow ratings, where most other high-yielding income investment companies have the majority of their portfolio and investments well below investment grade. We believe that investors should focus on the underlying credit quality of our assets relative to the extreme discount to now we are currently seeing in our share price. Since inception, we have reported no credit losses, zero impaired assets, and no material to deterioration of the credit quality within our portfolio. Lastly, I would like to comment on the intra-quarter SEC filing. On May 22, the company filed a mixed shelf registration statement with the SEC, which has not yet become effective. We currently have no plans to issue additional shares at StoneCastle Financial. However, with several initiatives in progress, including the rate step up for the U.S. Treasury’s Small Business Lending Fund program starting later this year, and the potential to invest in more than one pooled transaction. We felt it was prudent to file with the SEC, so that we will be prepared to raise capital when needed. The specific terms of any securities that we may offer, if we choose to do so, will be determined at the time of such offering and will be described in a separately filed prospectus supplement at the time of such offering. None of the statements made regarding the shelf registration constitute an offer to sell or the solicitation of our offer to buy the securities. So in closing, we made solid progress this quarter. But as I’ve said before, while quarterly results are important, StoneCastle continues to take a long-term view towards creating value for our present and future shareholders. Now, I want to turn the call over to Pat Farrell, to discuss the financial results in greater detail.

Thank you, Josh. I believe the detailed presentation of the components, which we have followed in the past, has helped many of you understand the value of the company. So I will continue to take some extra time to discuss our quarterly results. The net asset value at June 30 was $22.05. The NAV for StoneCastle Financial was affected by four components: net investment income, realized gains and losses, the change in the value of the proposed investments, and finally, distributions paid during the period. Let me walk through these components. Net investment income for the quarter was $2,345,457 or $0.36 per share. Net investment income reflects gross income from dividends and interest received from our portfolio investments minus operating expenses. Gross income for the second quarter was $3,954,180 or $0.61 per share. Gross investment income was up 23% from the last quarter, the company’s seventh quarterly increase since inception. The company’s operating expenses are comprised of various expenses such as advisory fees, interest expense related to our use of leverage, custody and administration fees, legal fees, ABA fees and other expenses. Operating expenses net of advisory fee waivers for the quarter were $1,608,723 or $0.25 per share. These expenses are up approximately 18% from the first quarter, primarily due to an increased use of the credit facility. The balance of the increase is from due diligence on our pipeline deals, advisory fees and legal expenses. The realized gains and losses reflect securities which were sold or called during the quarter. For the second quarter, this amounted to a gain of $1,036,964 or approximately $0.16 per share. The third component, changes in unrealized appreciation or depreciation of the portfolio, relates to how the value of the entire investment portfolio has changed from the previous quarter end to the current quarter end. The vast majority of the portfolio is valued by market quotations, broker quotes and other valuation sources. For the second quarter, the value of the portfolio decreased by $292,510, this amounted to a decrease of $0.04 per share for the quarter. The fourth component, affecting the net asset value is distributions. The cash distribution for the quarter was $0.33 per share, paid on June 29 to shareholders of record on June 19. To recap, we began the quarter with a net asset value of $21.90. During the quarter, we generated net income of $0.36, realized gains of $0.16, and the value of the portfolio declined by $0.04. The sum of these components offset by a distribution of $0.33 resulted in an overall increase in the net asset value of $0.15 to $22.05 at June 30. Now, let me update you on our credit facility syndicate led by Texas Capital Bank. As of June 30, the company had drawn $38.5 million of the facility. In accordance with the Regulated Investment Company rules, we may only borrow up to 33.3% of our total assets. Our leverage percentage at the end of the quarter was 20%. Now, I’d like to turn it back over to Josh.

Thank you, Pat. We appreciate you taking time to be with us on this call. Now, operator, we would like to open up the call for questions.

Thank you. [Operator Instructions] And our first question comes from the line of Greg Mason with KBW. Please proceed with your questions.

Great. Good afternoon, everyone. Thanks for taking my questions. Josh, on the potential pool securitization, is that something that StoneCastle is putting together, or are you buying an equity tranche in a third party managed pool?

Good question. So Citigroup is the investment leading the transaction. The expectation, if it gets done, is that StoneCastle Financial would be the investor – StoneCastle Financial would be the investor in the preferred stock of that vehicle. StoneCastle Financial will not be the manager of it, will not have any active control over it. And it is being contemplating currently as a static portfolio.

Okay, great. And to do this first one, do you need any additional equity capital to complete this first one, or do you have enough available capital on hand to be able to consummate it?

We believe we have enough on hand, and have securities that we’ve been and continue to sell in the market to generate the amount we would need to close that transaction.

Perfect. Okay, great. And then in the press release, you talked about $24 million in 4 investments, and then you highlight three of them for about $17 million. What would be the last one that looks to be about an $8 million investment in size?

That was one of our short-term holdings PFS, which we’ve – sort of our cash equivalent we’ve done for the previous quarters. We don’t tend to break that one out, because it’s not a core long-term holding.

Got it. Okay, great. And then of those three that you announced, all three of them are debt. Is there an active thought of moving towards debt versus preferred, or any commentary around debt versus preferreds going forward?

No, it’s more reactive than proactive, but that’s a good question. Since the Small Bank Holding Company Policy Act went into effect; what was it now? four months ago, five months ago; there’s definitely been increased interest from banks out there to utilize the subject market. So that seems to just be the flavor of the quarter. We are still working on a few preferred transactions that are in the queue and in diligence. So it’s not an active choice, it’s really reacting to what the bank demand is.

Okay, great. And then with the shareholder approvement of May of switching to the Delaware trust, can you talk about what the savings and kind of the timing of those savings could be with that change?

Sure. Well, one thing is, we went for shareholder vote, and we actually didn’t get enough votes to put a true. It wasn’t we didn’t get enough yeses. We just didn’t get enough votes. So we did actually – we never did convert. That said, I’ll let Pat speak to them. And, Pat has actually done a fantastic job of actually cutting those taxes anyway really crawling through the Delaware rule, when we found there are some interesting exemptions for the company of our type. Pat, maybe just take a second and…

Yes. Well, initially, you may recall that in the past we – the fee applicable to us is about $180,000 a year, turns out there is an exception for investment companies there. So our fee is not going to be $180,000. It would be more or like $90,000 a year. So going forward, that’s what we’re looking to approve for. Quite frankly, we had accrued a little bit extra from last year when we were able to get a retroactive reduction in our fee for last year. So we will not be accruing anything additional this year, and so far, late this year or beginning of next year.

Okay. That’s great. And then one last thing with the investment income, you had a nice jump up this quarter. Were there any one-time items, any prepayment knowledge, or anything that artificially boosted that investment income this quarter, the interest income?

No, not the interest income. The pay-down from the MMCapS definitely was part – pretty substantial part of the capital gains, but no, not on the income side, that’s reasonably the predictable income.

Okay. Great. Thanks, guys. I appreciate it.

It’s based on June 30, yes.

Yes, okay. Great. Thanks.

Thank you. And our next question comes from the line of Devin Ryan with JMP Securities. [Operator Instructions] Please proceed with your question.

Hello?

Yes. Hi, can you hear me?

Yes. I can hear you, Devin.

Yeah, hey, how it’s going? Yes, just quickly on the dividend and just love some maybe updated thoughts, great to see the dividend coverage this quarter. So I’m not sure if you’re ready to kind of share this yet, but how should we think about the timeframe and maybe appetite to raise the dividend, this is hopefully, the investment income continues to increase as more capital deployed from here?

That’s a fair question you ask. I want to have a good answer for you, because it’s clearly the board’s decision each quarter. But kind of like here we say, what I can definitely tell you about the interest rate forward curve, is that, its’ wrong. Hope it never actually follows. As we had said over many quarters and people were so focused on where our dividend was relative to our earnings. When we adjusted it last quarter, and we had said, and people rightly asked, well, should we view that as the future, is that really where it’s going to be. And we said, whenever we’re sort of making adjustments, it’s going to be wrong, because we’re constantly growing the company, right. We’re continuing to ramp and deploy. So, our view at the time wasn’t we’re going to constantly adjusted every quarter, who is going to make an adjustment that we thought would be safe for a while. Clearly, this quarter we exceeded that by $0.3 million. So this is kind of our base level. Whether in the future the board decides to increase it or do a special, we don’t know yet. But we remain focused as we only said on generating more and more income, our goal is $0.50 a share. It doesn’t mean we’re going to get there, but we’re trying. And credit quality, we’re not going to bend on. So we’re just going to keep working towards the goal.

Okay. That’s very helpful. I appreciate the color. And with respect to maybe the investing backdrop, we’ve seen credits spreads broadly lining up recently, and obviously, as you highlighted, given the makeup of your portfolio. You’re not seeing or expecting any deterioration, but in terms of pricing and maybe on the private side, the wider spreads creating better return opportunities or maybe changing the mix in terms of the view of where you want to be invested.

That’s a good question. What’s always been attractive to us about the community bank space, kind of the non-market traded, they were cheap to begin with. I mean, that’s my personal view, they were cheap to begin with. So they’re not trading as like an OAS spread over a benchmark. So finally, they’re very, very wide. In fact, at the discount that we’re currently trading on in the market, and we were sort of looking at this, and if we can a do non-deal road show at some point, it will help people understand it better. It’s something like some of the 1,000 over the curve for the credits we have at the current share price at StoneCastle Financial. For 75%, just will be credit. I find that to be ludicrous. So the value that’s there, it has been there, it’s not trading up and down a tick. Our pricing has remained, as you see from the deals we closed last quarter, it really hasn’t changed very much. We’re still in the high eights. So we don’t have any view that it’s going to widen or tighten for these smaller banks anytime soon. So it’s sort of steady as it goes.

Okay. Good to hear. And then, still getting through the filing, but if I look at the $186 million of investments, I’m not sure if you can, maybe give a flavor of how much or what percentage you would consider to be placeholders at this time. And really what your return would be, if you exclude the placeholders?

Well, can’t give a view of what the earnings would be. I mean, clearly, I know you’ve got a great model and you can get a sense of – if you put a placeholder in for X amount of dollars to be rotated. We have sort of earmarked at the moment that if this pool were to happen, it could be $40 million to $60 million needed for that piece. So that’s probably a fair number for you to think about what we would rotate out of the portfolio.

Got it. Okay, great. That’s helpful. And then just lastly for me the limited partnership with, I believe, Priam Capital, what exactly, is that’s $1million on the statement here?

Sure. That’s actually a great question for a really, really cool deal. Years before, believe it or not, StoneCastle Financial wasn’t even launched; we were involved in trying to help restructure 1st Mariner, then in Baltimore. And that deal, believe it or not, finally got done by the lead party, an institutional investor Priam, but got done after we launched StoneCastle Financial. So, we arrange [ph] with Priam is kind of a favor for helping pull that yield together for them to let us do an un-promoted investment into the 1st Mariner transaction. So it’s technically an investment in the single purpose private equity fund that owns 1st Mariner, but we don’t pay any fees to Priam.

Got it. Okay, great. That’s it for me. Thanks for taking my questions.

Of course.

Thank you. Our next question comes from the line of Dan Nicholas [ph] with WD Baird. Please proceed with your question.

Great. Thanks, guys. Josh, just kind of following up on your high-level thoughts on the community banking space, I know the M&A environment has been, or the potential for M&A has been a big part of – part of your thesis on liking the space. Just hoping you could update us on kind of what you are seeing and hearing out there among community bank’s put buyers and sellers, what you’re hearing and kind of feeling right now?

Well, I’m feeling like people are still getting older. So that doesn’t mean [ph] you’re going to drive the M&A wave. It hasn’t changed, the buzz is still out there that you have board meetings with an aging management team and boards across this country, and they’re coming more and more to the conclusion going alone even though – without losing money, they’re making money. But they’re just – they can’t really grow, they can’t find new common shareholders to invest. We’ve had a few of them take us up on investments. That’s part of the drive here. It’s that, if they do want to stay independent, they can do it through either preferred or sub-debt rather than common equity at least to some extent. They can use a huge amount of their balance sheet or further capital structure for that. But I do think the trend is going to continue. You’re going to see a lot of small-on-small mergers going on. I mean, what the final number of banks is, who knows. But I do think it’s 100s or 1000, 2,000 banks less over the next five to ten years. It’s going to be a fair amount of consolidation.

Okay. Thanks. I think all – rest of my questions were asked and answered. Thanks, guys.

Alright.

Thank you. There are no other questioners in the queue at this time. I would now like to turn the call back over to management for any closing comments.

Sure, well. As always, we appreciate your continued support to StoneCastle Financial. And we look forward to seeing you on the next call in November. Everyone, enjoy the rest of the summer.

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. And we thank all of you for your participation.