ArrowMark Financial Corp. (BANX) Q3 2016 Earnings Report, Transcript and Summary

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

Good afternoon. Before we 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 September 30, 2016. The Company undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of today, November 10, 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 third quarter 2016 investor call. In addition to Rachel, joining me today is George Shilowitz, 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, followed by comments on latest FDIC community banking industry report. Then I will turn the call over to Pat, who will provide you with greater detail on our financial results before I open up the call for questions. StoneCastle Financial is celebrating its third anniversary as a public company, if I sink back to Investor Meetings during the road show we talked about investing the portfolio for a long term strategy, producing a consistent and stable income stream and targeting a dividend yield of approximately 8%. And some things we would have done a little differently in hindsight but 36 months later the company is well in its way to achieving its stated objectives. StoneCastle has invested a majority of the portfolio in investment grade equivalent securities scored by Kroll, produced an estimated annualized portfolio yield of nearly 9% and delivered cumulative distributions $4.88 or approximately 20% of our initial offering price of $25 per share. This performance occurred in the interest rate environment had seen over 100 basis point decline in the 10 year treasury and with many other investors vehicles are farther adding the risk for yield. Since inception and in the current quarter I’m pleased to report that our portfolio currently has no material created issues or default. So, you will not be surprised as we report the third quarter relatively quiet quarter for the company. We reported earnings in excess of distributions and an increase in NAV. I’m pleased to report that in the third quarter StoneCastle generated total earnings of $2.7 million or $0.42 per share. The company’s net investment income was approximately $2.5 million or $0.39 per share and realized capital gains were $176,000 or $0.03 per share. The net asset value per share increased $0.08 to $21.29 as of September 30. Now I’d like to spend a moment on the composition of the portfolio which has not changed much since last quarter. As of September 30, the portfolio of asset categories as a percent of total investments were 32% in preferred stock, 25% in credit securitizations, 23% in Trust preferred securities, 17% in term loans and other debt securities with the remaining 3% of the portfolio comprise of common stock and other securities. The full schedule of investments can be found in the company’s SEC filings and on the company’s website. During the StoneCastle Financial invested $9 million in one investment which was offset by calls of $25.4 million from four investments. The company also received $40,000 in pay down from six investments and approximately $511,000 from the sale of Countrywide Capital IV. Now let me take a moment to comment on the company’s current pipeline and the market environment. As we’ve previously discussed newer deal tend to take anywhere 60 days to 90 days until closing. We received several call notices in the middle of the third quarter and that timing impacted our ability to close new deals during the quarter. Subsequent to the quarters StoneCastle closed deal totaling $8 million and those investments will be discussed on the next call. We continue to originate a proprietary deal flow with favorable terms relative to the market because StoneCastle focuses on transactions that are either too small or otherwise not the right fit for a syndicated broker dealer transaction. StoneCastle remains able to source deals with attractive credits higher than it was available via syndicated market transactions. Let’s take a moment to look recently syndicated deals by the broker dealer community. During the past six months there were approximately 26 community banks bode into debt transactions with rates ranging from 5% to 7%. After narrowing down the list of banks with comparable asset size to our target market we found total issuance of about $350 million from seven financial institutions. Also from transaction with single bank ten year non-qualified subordinated debt scored on average to probably minus already. All were executed in the 5% to 5.6% range. By way of contrast and equity investment in StoneCastle Financial earned a dividend yield of approximately 8% inclusive of management fees. StoneCastle investor can pick up 240 to 300 basis points of yield relative what rest of could earned through the single issue text income investments. Along with this yield advantage StoneCastle shareholders received both a diversified portfolio of approximately 120 community banks spread across 38 states and in our opinion benefit from one of the most experienced professional investment advisors focused on bank sector credit risk. And at this point I’d like to address our StoneCastle asset management adds broader value to the investment portfolio. In StoneCastle Financial’s portfolio produced an estimated annualized current yield 8.96% up from 8.33% in the third quarter year. This yield offered a credit spread of approximately 740 basis points over the ten year treasury which was 1.60% at quarter end. Let’s put more perspective around that statistic. The most widely tracked corporate bond, the BFA U.S. corporate triple B effective yield included 975 corporate issuers all with similar credits and durations as our portfolio. On September 30, the index had a weighted average coupon of 4.7% and traded at a premium generating a 3.3% yield or 170 basis points over the ten year treasury. In contrast StoneCastle Financial with 120 issuers and triple B minus scored Kroll rating as a portfolio yield of 8.96% and trades at a 12% discount. When benchmarked against this independent corporate index StoneCastle generated 566 basis points of yield premium at quarter end. Furthermore, I’d like to point out how our advisors add value relative to the interest rate environment. Since StoneCastle as IPO the ten year treasury fell over 100 basis points from 2.75% to 1.6%. Yet, our estimated annualized portfolio yield has been steadily rising from just over 8% in Q1 2014 to approximately 9% over the last four quarters. When looking at the same Q3 comparison year-over-year the ten year treasury fell 46 basis points and our portfolio increased by about 60 basis points. Given these facts I would like to encourage the analysts who follow us to examine the value of our stock from a different perspective. You will find that while StoneCastle Financial trades at a discount if the same assets were held in an open-end vehicle the company would be valued in NAV. Including this point we believe there are relatively few investment options in the market with the same risk reward profile and relative value to StoneCastle and we welcome a discussion to challenge our assumptions. Now let me point out another perspective on the company. StoneCastle Financial is a unique investment vehicle with structural investment advantages we believe are only partially understood by the market. An often overlooked fact is that a number of StoneCastle Financial’s underlying investments particularly subordinated debt, senior debt and term loans rank senior in priority to Trust preferred securities, TARP, SBLF, preferred shares and common shares. These securities ranked relatively senior in the capital stack and therefore provide several structural advantages to our portfolio. For example, these securities have a lower risk of nonpayment because they are non-deferrable securities as opposed to common, preferred and TARP that can defer distributions. A second structural advantage is that these securities receive repayment in the event of bankruptcy or liquidation before the classes of securities just described. And third, typically valuations for these securities can be less volatile because of their seniority. These structural advantages along with the company’s strong focus on credit continue to differentiate StoneCastle from other income vehicles in the marketplace. Now let me turn to the community bank industry as a whole. We have always been impressed with the history of the community bank space in this country. For nearly 80 years and throughout many varied economic cycles, this industry has provided investors with steady returns and issuer performance. Since 1992, the average annual return on equity for the community banking industry was 8.5% which includes the recent financial crisis. As noted in the FDIC’s latest quarterly banking profile for Q2 2016, aggregate earnings across the 5,602 FDIC insured community banks was 5.5 billion up 9% from the same period last year. Earnings were driven predominantly from the increased revenues in net interest income and non-interest income. This report, which is publicly available at www.fdic.gov, stated that in the second quarter of 2016 nearly 60% of community banks reported increased earnings. The report also highlights that asset quality improved for all major loan categories with the exception of commercial and industrial loans. The non-current rate of 1.05% is down 6 basis points from first quarter 2016 and 53 basis points below that of non-community banks at 1.58% during the same period. The rate of net charge-offs declined 1 basis point to 0.13% from the first quarter 2016. It was the lowest Q2 rate on record over the last 10 years. In Q2 small business loans by community banks were reported at 300.7 billion up 9.5 billion or 3.2% from last year exceeding the 2.8% growth at non-community banks during the same period. I’d like to repeat that small business loans made by community banks totaled 300.7 billion up 9.5 billion from the prior year, this statistic highlights the powerful impact community banks have on local communities given that 75% of all job creation is from small and medium sized businesses according to the small business administration. I’d also like to point out that community banks provide local financial services for approximately 1,200 counties or 37.5% of all U.S. counties including 900 counties that are exclusively served by 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 at September 30 was $21.29 per share, up $0.08 per from last quarter. 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 $2.51 million or $0.39 per share. Net investment income reflects gross income from dividends and interest received from our portfolio investments minus operating expenses. Gross income for the third quarter was $4.25 million or $0.65 per share. 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 $1.73 or $0.27 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 third quarter, this amounts to a gain of approximately $176,000 or slightly below $0.03 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. For the third quarter, the market value of the portfolio increased by approximately $214,000 or slightly above $0.03 per share. As I note each quarter, the vast majority of the portfolio is independently marked from broker dealer quotes. The quarterly fair value is provided by a minimum of two quotations and is an independent third-party assessment of the current liquidation value of the portfolio. I’d like to highlight this point, valuation marks are true representation of portfolio liquidation value nor theoretical bid nor a self marked bid like many BDCs. We do not believe the company is given due credit for this particular attribute of our financial reporting. To speak this fact in other way, the closing stock price of StoneCastle Financial Corp as of September 30 traded at approximately 12% less than the actual market value of the net assets in the portfolio. The fourth component affecting the net asset value is distributions. The cash distribution for the quarter was $0.37 per share, paid on September 30 to shareholders of record on September 27. As Josh mentioned StoneCastle has distributed cumulative cash dividends of $4.88 per share for a cumulative return of 19.5% and 20.8% of our IPO price and inception NAV respectively. In summary we began the quarter with a net asset value of $21.21 per share. During the quarter we generated net income of $2.51 million, realized gains of approximately $176,000 and the value of the portfolio increased by approximately $214,000. Some of these components offset by distribution of $0.37 per share resulted in a net asset value of $21.29 per share at September 30. At the quarter end, the company had total assets of $184.3 million consisting of total investments of $176.7 million, cash of $3.5 million and other assets of $4.1 million which includes receivables and prepaid assets. Now let me update you on our credit facility. As of September 30, the company had $35.25 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 19.1%. 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 Christopher Testa from National Securities Corporation, please go ahead.

Hi good afternoon guys, thanks for taking my questions. Just looking at the origination volume relative to prepayments is it safe to say that a lot of the repayments came towards quarter and therefore kind of hindered your ability to fund the originations by the end of the quarter?

Yes that’s a fair assessment. Right now, as we’re moving into Q4, we’re feeling very good about the pipeline and our general view discuss we’ve the visibility as we will end the quarter quite strong on originations. So yes, it was really a timing issue.

Okay, great. And just kind of segway from that. Do you feel that I know you had mentioned you did $8 million or so in origination thus far in the quarter, do you think that that’s going to pick more now that the election uncertainty has finally resolved itself, so are you expecting more deal flow to be towards the end of the quarter now? Do you think banks are kind of holding back somewhat because of that?

No, I don’t think banks are holding back although who really knows, little hard to fortune the lateral thing, but no, the pace of deals even going into Q4 and things that we have in the queue it doesn’t gaited by before or after the election. Q4 is always an important period for banks they have yearend financials and regulatory reporting so they do tend to want shore up prior to yearend to do capital planning for the year. Some of them may want to close M&A transactions, reduce certain things so that their final year FY1 and call report reflects that. So I don’t know if its election related, but Q4 tends to be reasonably strong.

Got it. And what do you think quarter to-date in terms of repayment?

We haven’t any, so fingers crossed on that. If you look back historically the fourth quarter does tend to be one of the larger quarters of the year, but so far, no official notices from anyone and we hope that calendar is…

We’re not going to pick up the phone.

And has there been any further update on Chicago Shore?

They have been quite reporting their financials, regulatory order is not yet released but the numbers still look good, continues to progress latest update with the institution gives us confidence but no change in the dividend cash pay in the short term.

Got it. So just increased performance, so things are looking good operationally there?

Things are looking good operationally, one of the issues in the public order is the capital raising even they’re not below minimum and they had not yet completed that yet so would be unrealistic that the regulators with that and off the order until that done.

Right, okay, that’s all from me. Thanks for taking my questions.

[Operator Instructions] And we do have the question from Chris [indiscernible] from KBW, please go ahead.

Hi guys this is Chris filling in for Collin. I was just wondering how you guys LIBOR move maybe that just a cost of the debt facility over the course of the quarter and how you guys might do that going forward with or without rate rise in December?

Good question. Well, there is a lot going into that we’ve been electing to fund off one month LIBOR which has not been as wild or as expensive as three month LIBOR if you look at sort of the TED spread and differential between treasuries and LIBOR. LIBOR short term moves is driven more by the money market reforms and under [indiscernible] liquidity cover ratio which has driven $400 billion to $500 billion of uninsured deposit funding out of sort of the Yankee banks kind of larger banks that operate in the U.S. market and some domestic banks. Those funds came out of prime money market funds and went into treasury money market funds almost overnight, if you would have to chart that off from one of the government website it’s almost one for one inverse between the two. So that’s what driving LIBOR now. I can’t even - given the selection as to tell you what’s going to happen with interest rates as it relates to that wouldn’t even try. But right now the short end of the curve it really has moved up a bit this year but not a meaningful amount.

There was a little blip at the end of last quarter just because we’ve different tranches outstanding and depending on when those come up during the months with the one month roll. There may be a blip little bit of a couple of basis points, but that’s about it, I mean, it’s been very steady lately and I would expect it to stay there.

Okay, thanks. How often do you guys get to change or reelect one month versus three month basis?

It’s every month, so right now we’re on a one month roll so at any point we can change that and go back out to three months or two months. Right now, it’s month by month.

Great, that’s all I’ve for now. Thanks guys.

Sure, no problem.

Our next question comes from Devin Ryan from JMP Securities, please go ahead.

Good afternoon guys. Most of my questions have been asked here and maybe just one that could tough, but just trying to think kind of early reach if on election there has been a lot of talk about regulatory changes that could come for banks, Dodd Frank is getting broad up quite a bit. I’m just curious if there is anything within regulation, there is any repelling or dis-offering that you think would impact maybe the outlook for M&A in the bank or anything that could impact the outlook for M&A in the bank space that could impact the portfolio? And then just, maybe just more broadly is there anything you’re watching for in terms of kind of regulatory changes that could occur that could be good or bad for just the backdrop of financing or something else in the business?

Well, given that I’ve 48 hours to digest the attention, I’ll give you my early crystal ball. If Dodd Frank were to be repealed I think there is a bit of a misunderstanding of what could or would happen. So it’s gone one front. Dodd Frank had about 660 pages rulemaking in a 2,000 page document, little more than a half now, the rulemakings have been taken. But what Dodd Frank mandated if you look through really take it or look at it is it says that regulations will be promulgated because of Dodd Frank, right. So in other word it says regulators will do this as mandated. But once it’s done and it’s now in regulations in various agencies whether it’s STAD, FDIC even if you repeal Dodd Frank that doesn’t make it go away it’s now in the rigs. You actually have to pass a new [LOTA] undo it or pull it out, and I’ve been talking to a lawyer about that in the last of days. So either at Dodd Frank it’s repealed it doesn’t mean that all of the Dodd Frank rules go away, many of them are now codified would have to be ripped out which is a much harder thing to do. It could happen but it will take much longer. The other side is, let’s say that is repealed or CFPB goes away. The general view is that we’re quite optimistic you can see that in bank’s stock this week and that would - regulations both the small and large banks together maybe large banks do get few thousand people in the compliance department I don’t know if that’s good or bad for the economy, but it just reduces a lot of burden on small banks that really will never the target of these regulations in the first place so that’s only good. And we’ve looked quite closely on what’s going on with the change in treasury and the bond market relative to stock I mean, it’s today hard to say, but Layman you would say but the temperament is that loser regulations in all kinds of industries could spread economic growth I think people are generally interpreting the stock market move on, yet they’re worried about inflation as a result of touch growth and sort of over employment that could occur whether is infrastructure building or increased manufacturing which could put wage pressure on, which then could raise short term rates and then you have a view around what goes on in. The higher rates are better for banks that’s how it has been constant. So there is just a lot of moving parts around that I don’t see anything would range bad, it’s neutral to quite good for banking if we just narrow to what’s the direct effect on banks and not the economy as a whole.

Great, that’s really helpful color just wanted some kind of early perspective from your seats, I appreciate that. And I guess there is nothing when you look at your portfolio to the extent there is a greater toleration in M&A or in terms of how, what the exposures are, is there any implications when you look at what you own - to the extent that would happen?

It’s really too dis-chunk, I mean more M&A in theory mean more capital needed for the acquisition on the other hand more economic growth that does have an effect on market. So if more people are employed then you need more ancillary businesses to put those people, smaller manufacturers supply to large manufacturers to make more things and hire more people which means those companies need more capital expenditures which means more business loans and commercial loans. So we’ve had a very tepid economic profile for a long period of time, it’s not a political comment just economic comment. So if economic growth would reoccur that could mean more lending and bank growth which means more capital need much like what we saw mid 1990s and the mid 2000s.

Great, okay, thanks Josh.

This concludes our question-and-answer session, I’d like to turn the floor back over to management for any closing comment.

Thank you, operator. Again over the last three StoneCastle Financial could not have achieved the success of our organization without your continued. So on behalf of the entire executive team and Board of Directors thank you and we wish you a very healthy and happy holiday season and we will see you in 2017.

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