ArrowMark Financial Corp. (BANX) Q1 2016 Earnings Report, Transcript and Summary

Welcome to the StoneCastle Financial Corp. Q1 2016 Investor Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host Ms. Rachel Schatten, General Counsel of StoneCastle Financial. Thank you. You may begin.

Good afternoon. Before I begin this conference call, I’d like to remind everyone 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 semi-annual reports of the Company. StoneCastle Financial has based the forward-looking statements included in this presentation on information available to us as of March 31, 2016. The Company undertakes no duty to update any forward-looking statement made here in. All forward-looking statements speak only as of today, May 5, 2016. Now, I will turn the call over to StoneCastle Financial’s Chairman and Chief Executive Officer, Josh Siegel.

Thank you, Rachel. Good afternoon and welcome to StoneCastle Financial’s first quarter 2016 investor call. In addition to Rachel, joining me today are George Shilowitz, the Company’s President; and Pat Farrell, our Chief Financial Officer. I would like to start the call today with a review of StoneCastle Financial’s quarterly results and portfolio highlights to be followed by brief comments on the Company’s strategy. I will then turn the call over to Pat, who will provide you with greater detail on our financial results before I open the call for questions. I am pleased to report that in the first quarter StoneCastle’s total earnings were $0.44 per share, comprised of both net investment income and realized capital gains. Net investment income for the quarter was approximately $2.6 million, or $0.40 per share, reflecting an increase of nearly 40% year-over-year. Capital gains for the quarter were approximately $291,000 or $0.04 per share. The net asset value per share decreased $0.53 per share to $21.09 at March 31 due in part to the general price declines in the financial markets during the first quarter. Now, I would like to move on to discuss the broader portfolio. As you may recall, we closed community funding on October 2015. As a result, this is the first full quarter with community funding contributing to our gross income. With an effective yield of 10.49%, this investment resulted in a substantial increase in the earnings power of the company. We are pleased that the first full transaction made a significant contribution to our financial results and we endeavor to work on a similar transaction at some point in the future. During the quarter, StoneCastle Financial invested $20.7 million in five investments, including three new issues. These investments were offset by issuer calls and partial repayments of $17.5 million from 14 investments and sales proceeds of $6.3 million from five investments. As discussed on prior calls, the company has been reducing its position in Medallion Financial Corp. As of the end of the quarter, we had fully exited disposition. At March 31, the portfolios asset categories as a percent of total investments were as follows: 37% in preferred and convertible preferred stocks, 24% in preferred shares of the bank credit securitization and 23% in trust preferred securities. The remaining 16% of the portfolio is comprised of term loans, debt securities, common stocks and other securities. The full schedule of investments can be found in the company’s SEC filings and on the company’s website. We believe our focus on the credit of the banks in the invested portfolio continues to differentiate StoneCastle Financial from other income vehicles in the marketplace. As I have mentioned a number of StoneCastle Financial’s underlying assets specifically those within the securitization ranks senior in priority to trust preferred securities, TARP, SBLF, preferred shares and common shares, thereby providing a structural advantage as well. Within the community funding asset pool, roughly 97% of the banks received an investment grade equivalent credit score by Kroll Ratings and approximately 91% received an investment grade credit score by Moody’s RiskCalc. The banks that were not scored investment grade received a BB equivalent. Within the entire StoneCastle Financial portfolio, majority of our bank investments were scored BBB minus or better by Kroll. This quarter StoneCastle received notification that Chicago Shore Corporation elected to defer its first quarterly dividend payment on their Series A and Series B 9% cumulative preferred stock as permitted by the terms of their security. The current value that StoneCastle’s holdings in Chicago Shore is approximately 5.4 million. By way of background, in March 2014, at time the StoneCastle purchased these secondary market securities, the company identified the Chicago Shore had a few isolated problem loans and the quality of these particular assets were factored into the company’s initial credit analysis. During the bank’s year-end regulatory review, regulators asked what the bank account for these assets more conservatively. The bank elected to defer the dividend payments prior to any formal regulatory action should any occur. For those of you unfamiliar with cumulative and compounding preferred stock, I want to point out that under GAAP, income from an investment in a preferred stock that is deferring payments on a cumulative basis cannot be accrued. Therefore on a go forward basis, StoneCastle will be tracking the accruing compounded payments in our financial statements. Pat will provide more details and address the related financial adjustments in his remarks. I want to reiterate StoneCastle Financial has invested in what we believe to be a portfolio of healthy community banks with a steadfast pursuit of credit quality. The investment committee constantly monitors the portfolio for negative and positive trends in our underlying banks. As of March 31, StoneCastle Financial – StoneCastle Financial’s invested portfolio continues to have no charge offs. In fact, I would like to point out that the community industry as a whole continues to be quite resilient. This industry segment consistently produces ROEs in the mid 9% level. As noted in the FDIC’s Q4 2015 quarterly banking profile, close to 57% of the community banks in the FDIC universe reported an improvement in earnings over the prior year. This report which is publicly available at www.fdic.gov also stated that nearly 70% of community banks increased net interest income year-over-year and over 50% of community banks increased their small business loans over the same period. The report also sites that asset quality improved across the industry, specifically that 57% of community banks reduced their non-current loan balance in Q4 2015 from the prior year. Non-current loans now stands at 1.1%, the lowest level since Q3 2017. And to further emphasize this point, the non-current rate for community banks was 55 basis points below that of non-community banks, which was 1.65%. We believe that current market conditions present attractive buy valuations and we continue to monitor the market for such opportunities. In closing, StoneCastle remains in a unique position to take advantage of these market opportunities as we believe we’re the only publicly traded permanent capital vehicle focused on community banks. Now, I want to turn the call over to Pat Farrell to discuss the financial results and provide details on the underlying value of the company.

Thank you, Josh. As I do each quarter, I will present the financials by going through the detailed components to help you understand the value of the company. The net asset value as of March 31 was $21.09 per share, the NAV for StoneCastle Financial is comprised of four components: net investment income, realized gains and losses, the change in value of the portfolios investments, and finally distributions paid during the period. Let me walk through these components. Net investment income for the quarter was $2,593,111, or $0.40 per share. Net investment income reflects gross income from dividend and interest received from our portfolio investments minus operating expenses. Gross income for the first quarter was $4,315,870 or $0.66 per share. The dividend payment on the preferred shares, which was deferred Chicago Shore Bank for the quarter was a $147,375. This decreased our gross investment income by $0.02 per share in the quarter. Under GAAP we cannot recognize these dividend in our income until this is cleared by Chicago Shore. However, as Josh mentioned, the Chicago Shore preferred dividends are cumulative and compounding. Therefore StoneCastle is in essence earning the dividend but not able to accrue the income. At the time the bank resumes dividend payments, the bank will be required to pay all the deferred payments and the compounded rate of rate on missed payments along with the current dividend due. These preferred share dividends must be paid before any dividend declaration to common shareholders of Chicago Shore. Now, I would like to review the company’s operating expenses, which are comprised of advisory fees, interest expense related to our use of leverage, custodian and administration fees, legal fees and ABA fees. Operating expenses for the quarter were $1,722,759 or $0.26 per share. Total expenses were flat from the prior quarter. The realized gains and losses reflect securities, which was sold or called during the quarter. For the first quarter, this amounted to a gain of $290,780 or $0.04 per share. The third component changes in unrealized appreciation or depreciation of the portfolio related to how the value of the entire investment portfolio has changed from the previous quarter end to current quarter end. For the first quarter, the market value of the portfolio decreased by $4,003,521 or $0.62 per share. As I note each quarter, the vast majority of the portfolio was valued independently by market quotations and broker dealer quotes. The quarterly market value is provided by a minimum of two quotations and is an independent third-party assessment of the current liquidation value of the portfolio. The fourth component affecting the net asset value is distributions. The cash distribution for the quarter was $0.35 per share, paid on March 29 to shareholders of record on March 21. In summary, we began the quarter with a net asset value of $21.62 per share, during the quarter we generated net income of $2,593,111, realized gains of $290,780, and the value of the portfolio decreased by $4,003,521. Some of these components, offset by a distribution of $0.35 per share, resulted in a net asset value of $21.09 per share at March 31. At the quarter end, the company had total assets of $189.3 million consisting of total investments of $181.5 million, cash of $4 million and other assets of $3.8 million. Other assets include receivables of $3 million and prepaid assets of approximately $800,000. Now let me update you on our credit facility. At March 31, the company had $50.5 million drawn from 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 26.7%. Now I’d like to turn it back over to Josh.

Thank you, Pat. Now operator, we would like to open up the call for questions.

Thank you. [Operator Instructions] Our first question comes from Devin Ryan from JMP Securities. Please go ahead.

Hey, thanks good afternoon. I guess just starting on the commentary on Chicago Shore, I’m sure there are some company specific nuances there. And I just want to make sure, I mean, is it fair to assume that the only investment with that issue in the portfolio that you see? And then maybe just more broadly you highlighted credit quality that the banks currently is pristine. I’m just curious is there any pockets that maybe early indicators are changing or do you still feel great about the credit trajectory for the portfolio.

Chicago Shore, good question. Chicago Shore is actually not a new credit issue. The credit issue was from credits that were extended at this point probably over three years ago. So it’s not that the credit time in U.S. is turning and that’s a new issue. It was a legacy issue where on a year-end review by regulators in a normal supervisor view, they basically said they wanted to increase the general reserves of the bank. So the bank, of course, capitulated and said, sure we’ll take the charge, which reduced capital. And just to be conservative they said we’re going to elect to defer. To this date as current as today there’s still no notice of any regulatory order against the bank, could very well come, but in the meantime they reported a Q1 numbers as a public data on fdic.gov and they actually had a strong Q1. So for this bank it’s not a new issue. As it relates to credit in general, we’re generally paranoid people, so we always look for credit issues before they occur. We’re not seeing anything across the whole portfolio, there’s nothing systematic. And there’s of course, continued buzz from the industry itself, from regulators, from American banker, about oil and gas related. I think we talked about that last quarter there’s nothing new. We’re not seeing any credit issues across the portfolio.

Understood, yes, I wasn’t necessarily trying to connect the two and imply that the Chicago Shore, was a new credit issue, I guess, just want to make sure that the regulatory or the regulator pressure there that was really just company specific and that there’s nothing that this changed where this could be something that that occurs within other credits or other positions in the portfolio.

I have no evidence of this as anything other than a review of a specific handful of credits at one specific bank.

Got it. Okay good. I just appreciate the clarification there. And with respect to the credit facilities, you guys have drawn $50 million of the $70 million, I think, that’s up from $25 million last quarter. So you still a little bit of room to expand. So is it reasonable to think that you’ll kind of move toward the limit here, during maybe the near-term or are you kind of comfortable where you guys are on the credit line?

From a comfort level for us today give or take is around $60 million mark. So we’ll [indiscernible] have some opportunities present themselves. There have been investments, post quarter end, so we’re still continuing to use it. And we do expect that will be caused from time-to-time, so we’ll always be cycling out that’s why we like the fact that it’s a committed revolver. So we can not have the drain when we don’t need it and we can draw we do need it. Plus we continue to cycle out of securities as needed. So if we can replace something with equal or better credit at a better yield, then we’ll cycle out. And that of course, always rings in our mind about a future securitization if we can get the market to capitulate let us do one. But we cycle out just trying to maximize the earnings of the current portfolio.

Thank you. Our next question comes from Christopher Testa from National Securities Corp. Please go ahead.

Hi, good evening, thanks for taking my questions. Just with again kind of piggybacking on the Chicago Shore, can you go into more detail Josh, I guess on what exactly the regulatory issue was if you’re able to discuss that.

Sure, it’s nothing unusual. So when you have a standard year-end on a regulatory cycle, as far as we know, this was not a surprise pop up, this was a normal scheduled review. Regulators will go through your loan book, and they may ask you to downgrade or agree with the assessments that a bank has and quite typical. We knew that there were some credits and this is very symptomatic of sort of crisis era, charge-offs or NPLs, where a bank says look we know the borrower, we know the collateral and we feel that our resolution is x and a regulator comes in and says, yes, but I want you to mark it down and rather you guys be conservative. You don’t have a ground to argue it. And in this case, the bank didn’t want to argue because they said fine, we’ll take the charge and we’ll increase our reserves and they did. And while, there’s no regulatory ask, we talked to the bank the regulators did not ask for them to defer on the TARP. And again the TARP is [indiscernible] compounding. So it’s a normal term. They just chose to be ahead of it, because you don’t want everyone to anger a regulator.

Got it.

And they made much in Q1.

Okay, all right. That’s good, that’s helpful. And I guess with, I know you mentioned, well I guess coming back so to CLO the one you can’t really have outstanding that you formed. How has that been sailing with the volatility in financial markets now? Should we expect the cash yield to go up, now with those better yielding reinvestment opportunities? Am I looking at that way, does that operate in kind of like a traditional CLO.

No, it doesn’t operate like a traditional CLO. It’s only a CLO in the fact that it’s a securitization of loans, but it’s a static portfolio.

Got it.

So there’s zero reinvestment. And given that it’s ten-year fixed liabilities and ten-year fixed assets, it’s just a static lock. So we’ve had zero credit issues, it’s made all schedule payments, so we’ll continue at least unless, until further notice as expected.

Great. And do you have, I know you mentioned [indiscernible] forming a new securitization, is there any talk on the timing of that one that could occur?

I wish I had an answer. I would love to tell you an answer. But it’s dependent on getting critical mass of banks like the first one, which we’re underway, but we’re still a long way. And for the capital markets sort of being right and as you know the CLO market since the fall, the real CLO market has been quite off, in fact recently shut down. I think there was some recent articles about how the new issue flow for the traditional, large players in that market are just not getting deals done because of the market not cooperating. So at the moment, we’ve heard that there is a bid for the type of deal we do, but they don’t have the banks yet. So it is one of those things that we’re not going to be able to forecast timing. We will do it as soon as we can whenever that might be.

Right, and if you would – if you have banks wind up let’s say tomorrow, do you anticipate that they would be a good deal of appetite for debt investors in that vehicle, just kind of given of the energy wise around banks right now.

Well it’s the crystal ball answer. But from comments that we’ve talked to of the large players who do the placement, the major money center firms, they said there is demand but I think we have to take that with a grain of salt, we won’t know until we actually try. And the nice part is where we do these deals, but we’re not warehousing the risk and sitting on it. If it happens, you do it. If the arbitrage and the values isn’t there, you just don’t do it. So there’s really no harm. So we won’t know until already there to have a full diversified portfolio of banks and then see where the market is.

Okay, got it. And out of the unrealized depreciation this quarter, how much of that was just from the general bank market and how much of that was specific to the credits in the portfolio?

This is Pat, I’d say that, certainly community funding in Chicago Shore were probably about half of it and then the rest of it was pretty much the rest of the portfolio, except for ST Financial [ph] which was about $0.06 of the amount. That was one of the securities we sold during the quarter. But in light of the change in market prices during the first quarter when we sold it we sold it for about on a per share basis about $0.06 less than, where we had it marked at, at December 31.

But there were – just to make sure we’re also answering your question. Other than in Chicago Shore there were no credit related marks, meaning it didn’t come down because credit changed it was just the Q1 volatility and pricing.

Right.

Yes, that’s also was fine. Thank you.

Yes.

Our next question comes from Bryce Rowe from Robert W. Baird. Please go ahead.

Hi, just a couple questions. One quick follow-up on Chicago Shore, Josh were they paying some form of common dividend to common shareholders.

I don’t believe they were, I think, they’ve only been paying on their preferred and trust preferred.

Okay. And then second question is pipeline, do you have a pipeline of kind of single issuer or sub debt banks lined up.

We do, we have a pipeline of sub debt and some preferred transactions. So the flow continues it’s the whole debt issuance market for banks have been slow. I think there was a national article on that recently. So I would agree. But we’ve been getting deals done. And we have a pipeline that wouldn’t pay it a giant pipeline, but it’s active. And frankly we don’t have a giant amount of capital to spend. So it’s actually well matched.

Got it, okay. That’s all I had, thanks.

You got it.

Thank you. Now I would like to turn the floor back over to management for any closing remarks.

Thank you operator. On behalf of the entire management team and our Board of Directors, I would really like to thank you for your continued support of StoneCastle Financial. And we’ll talk to you next quarter.

This concludes today’s teleconference. Thank you for your participation. You may disconnect your lines at this time.