Welcome to the StoneCastle Financial Corp. First Quarter 2019 Investor Conference Call. [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.

Good afternoon. Before we begin this conference call, I'd like to remind everyone that certain statements made during the call maybe considered forward-looking statements based on current management expectations that involve potential risks and uncertainties. Actual results may differ materially from the results stated in or implied by these forward-looking statements. This could 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, 2019. The company undertakes no duty to update any forward-looking statements made herein. All forward-looking statements speak only as of today, May 2, 2019. 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 2019 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 an update of StoneCastle Financial's quarterly results, a review of the portfolio and some brief comments on the market environment. 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. Net investment income for the quarter was $2.5 million or $0.38 per share. Total assets were approximately $181.3 million, and the value of the invested portfolio was approximately $173 million. The net asset value at the end of the quarter was $21.63, up $0.20 from the prior quarter. This increase was predominantly due to the markets rebounding from the markets in Q4. We believe no meaningful credit issues currently exist within the portfolio, and the majority of the underlying banks continue to be scored investment grade by Kroll Bond Rating Agency. Now let me turn to the portfolio review. This was another quiet quarter within the community banking industry. In fact, according to S&P Global Market Intelligence, debt offerings by all U.S. bank and thrifts were reported to be down 48% in Q1 2019 from Q1 in the prior year. SNL reported six sub-debt deals closed during the quarter, raising approximately $200 million of capital with coupons ranging from just under 5% to 6.5%, with a weighted average coupon of 5.5%. During the quarter, StoneCastle made a small investment in [indiscernible] The Queensborough Company, Series A and B cumulative perpetual preferred shares, both of which are 9% coupons. During the quarter, we had call proceeds of $17.5 million from three…

Thank you, Josh. As I do each quarter, I will present the financial results by going through the components of the company's quarterly results in detail. The net asset value at March 31 was $21.63, up $0.20 from the prior quarter. The net asset value is comprised of four components: Net investment income; realized capital gains and losses; the change in value of the portfolio's investments; and lastly, distributions paid during the period. Let's look at these components. Gross income for the quarter was $4.2 million or $0.65 per share. Net operating expenses for the quarter were $1.7 million or $0.27 per share. Net investment income for the quarter was $2.5 million or $0.38 per share. This is $0.04 lower than the prior quarter, primarily due to loss of $0.05 of interest income due to the call of Baraboo at the beginning of January and the special annual dividend received in Q4 from our investments in PFF, which specifically accounted for approximately $0.02 per share. The loss of income from these two positions was offset by a decreased management fee and lower expenses. This offset of approximately $0.03 was due to lower managed assets, savings related to paying down our line of credit and other expense reductions. The second component affecting the change in NAV for the quarter is realized capital gains and losses. The net realized capital loss for the quarter was just over $91,000 or $0.01 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 first quarter, the unrealized appreciation of the portfolio increased by approximately $1.4 million or $0.22 per share. This was primarily due to a rebound…

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

[Operator Instructions] Our first question comes from the line of Devin Ryan with JMP Securities.

This is Brian McKenna for Devin. First question on the call proceeds in the quarter. Were these more idiosyncratic one-off events? Or are there any other underlying scenes going on in the market? Just trying to get a sense of how these could trend moving forward?

Yes, unfortunately, there aren't enough data points to have a trend. I'd say, to use your term, it's more idiosyncratic. The case of, for example, Baraboo, we knew that was a situation we could take advantage of where they had an opportunity to do a capital-related transaction, they needed the funding, we were able to extract out a good value, and we always knew that would be a short term position, but a very nice yielding position in the meantime. So no, I don't think there is any underlying trends here. In fact with rates as low as they are in the market right now, even a lot of things that were done pre-crisis are not being called away because the – you're not going to save anything compared to where the – those existing capital securities or capital instruments are. So I think, we'll probably continue to see a reasonably benign call environment, but no, there is no underlying trends driving anything.

Got it. Helpful. And then I appreciate the comments just on the backdrop and the benign investment landscape we've seen here for the last few quarters. But you've done a good job getting creative on the assets side to drive some incremental yield while you've also been disciplined on the expense side. So just curious if there's any other leverage you can pull kind of in the intermediate term to generate additional yield or earnings?

We're working on a number of things. I mean, I think the most important point to always keep in mind is, because the nature of these investments are quite long, these are typically 10 non-call five or could be perpetual non-call five. For preferred, if we deploy everything into the market today, we're locking in rate of return for probably the next 9.5 to 10 years. We don't love where the yields are right now. So we're not going to sacrifice 9.5 years for one or, two, or three quarters of short-term focus. Now that said, we're trying to extract out some interesting rate – cap rates, things in the banking space. We have a pipeline of some transactions that are in the queue. We went after a few things recently, missed on yield just because bid is so high for any fixed income product right now. We just – we're going to chase it down, but we do have things in the pipe that we think will still give us that ability to outperform. That said, when we went public in the third quarter or fourth quarter of 2013, and we're targeting a 9% yield as I'm sure you and everyone else on the phone knows, the spreads in the interest rate market have changed dramatically and yet we are still, knock on wood, maintaining over 9%. Can we do that forever? Hard to say. But I think we've done a reasonably good job despite the change in interest rate and credit spread environment of maintaining the yields where they are.

Yes. Got it. And just the last one from me. You kind of alluded to this with your remarks just there, but last call, you discussed exploring some alternative investments within the community banking sector, potentially with financial sponsors. So could you provide just an update on that – on this front? I'm just curious if you're seeing anything that's interesting that you're looking to explore a little bit more?

We're seeing some things, nothing I can disclose. Again those are more opportunistic. We are out there seeing what we can find still mostly related to bank balance sheet, but some things that are bank sector as well. So we're slowly building that out. Again, we're not in a rush, we're not going to hurry to go do one. When we find one that's compelling, that gives us a rate of return as we would measure well in excess of our perceived risk or quantified risk, then we'll do it. But we can't really give any forward-looking detail on the pipeline there other than we're working pretty actively on expanding the net.

Our next question comes from the line of Christopher Testa with National Securities Corp.

Just a little bit on one of the previous gentlemen's questions. On the call deals, just wondering, Josh, if you have a sense of, who's doing the refinancing, right? Because if somebody is apparently picking these things off and doing them at these highly unfavorable rates and locking them in for a while, is this – are there any new entrants into the market or I'm just trying to get some color on who's the one who's actually doing this?

The deals that have been getting done, which are only handful in the quarter. From what we've been able to research, it's mostly insurance company bid. Insurance companies have an ever-growing – if they are even a reasonable insurance company portfolio of long-term liabilities and they need long-term assets, and they have been just devouring anything that come in the market, notwithstanding sector. So that's where it's going. It's not a new entrant in the investment side. It's really – it's the insurance company bid, who's happy to hold things long-term. And right now, they just can't find enough product to generate yield, so they're going into every sector they can find, so that bid remains at the moment.

Got it. And do the insurance companies have the wherewithal to really be kind of what you guys do, boots on the ground, getting into a lot these small banks that most people in the country don't know exist? Or they just basically getting called by just several institutions and they just kind of do this when it pops up for them?

Yes, they're not doing anything on site. We know that from the management teams. They are buying deals – little club deals from folks like Sandler, KBW occasionally. There really aren't a whole lot of deals being done, but they're buying them as effectively part of a buying syndicate, not doing direct bilateral like we do. So I would almost question and you just don't know, I mean there are things we pass on that we know get done. Like you said, they're not boots on the ground. They're not going through loan files, they're are not interviewing management, they're not looking at regulatory exit exam, so good luck. I don't know how they're determining whether it meets their credit threshold or not because relying on simply small investment bank to say this is good stuff, that's kind of a fool's errand.

Yes. No, that makes sense. And I know one of the things we've discussed previously is tangible common equity to tangible assets that BANX has – I guess, you could call it into the stratosphere. I was just wondering, is this solely a function of their just being simply no loan growth? Or is there a fear component to this as well where banks want to really be well capitalized because they think that there is a decent amount of defaults coming down the pipe?

Well, it's a couple of things. I mean, one is, it's the awareness that CECL is coming and so it's better to retain the earnings, that's one. Two is the tax – the Trump tax cuts from a year and change ago, that create a lot more free cash flow, right? Because you lost 25, 30 points of tax expense that goes straight to retained earnings. And most banks haven't really raised their common dividend, so they're just retaining, that's the other driver. Pair that with generally – I mean it's the average is never the average. There are banks out there that are growing quite aggressively. And then there's a lot of banks out there that are just not growing or shrinking. Obviously those banks that are growing quickly, their capital ratios aren't staying as robust, but they're generating enough free cash flow to, for the most part, maintain the growth. But you do have others where they're just not seeing and that we sort of applaud the discipline. A lot of banks are just not seeing attractive opportunities, and they're just letting their portfolio either sort of maintain or even decline a little because they're still profitable. They just don't want to expose themselves to the credit risk. So when you have a smaller denominator and the same amount of capital, obviously, the ratio is improved, and that sort of what's going on.

Got it. And I know, it's sort of a blanket statement and there's always exceptions. But would you say that any bank in the current environment that's having robust loan growth is doing some foolish things?

There are some, not to throw anybody into the bus, who still play in the marketplace loans. There are some very nonbank traditional sectors. We don't think that's particularly a wise thing to do. It's still just a handful of banks, out of 5,400 banks, so it's not a trend. But yes, there are few. But most of the banks that you would normally see in the public markets that are higher growth, they seem to be doing it smartly. They're either originating into asset classes that do require specialized teams, it might be leasing, it might be SBA, which is picking up again, which is nice to see where you can extract decent yield in some government protection, but you can't just take a traditional commercial lender to do that, you actually need a dedicated SBA team who knows the rules. So those who are investing in the right staff and the right systems and you are seeing some of these faster growing banks bringing on technologies that are making, for example, the SBA loan underwriting space much more efficient. Yes, I think they are doing it smartly.

Okay. Alright that's helpful. And a last one from me and I'll hop back in the queue. Just – I know you mentioned speaking with the executives at the ABA that a lot of people are thinking about the next cycle is going to come. I'm just wondering, obviously, this is a bit of a crystal ball question, but just wondering where you kind of see the faults are? I mean, I don't think anyone, including you or I, thinks there's going to be anywhere near 2008, '09, but I mean, where do you see this potentially going? Just how severe if you had to quantify it?

Well, again, that is complete crystal ball. I would say that the general – when I pooled the room, we probably had 50 or 60 banks in the room. They were thinking the timing is 12 to 24 months, take that with a grain of salt, but that's just what a bunch of bank execs had to say. In terms of severity, I don't think anyone has been able to quantify because the issue is going to be more of two things. If you look historically, it's usually a liquidity crisis begets the credit crisis, right? There is a succession of new loans being made, which means there is no way to role the old loans, then they go into default and then the workout is the workout. Now, I think when we look at severity, the loan-to-value across the industry, as best we can determine, are much lower than they were back in 2007, 2008. So I don't think you're going to have the magnitude of credit losses. The frequency can still be quite high. But no one sort of is looking at this in a view of the losses are going to way outstrip our reserves and capital. A healthy correction and taking some losses isn't the bad thing. Occasionally, you have to do a little burn in the forest to maintain the forest health long term. I think that's the same here. We do it for a little cleanse, but I will be making it up if I could quantify what it's going to be, but I mean our forward-looking stress cases that we look at internally, just see it as a traditional – could be couple of points, three, four points of losses, which is well within the tolerance limit for an average bank, not even a great bank.

Our next question comes from the line of Chris OConnell with KBW.

So I just wanted to circle back on the kind of ancillary potential investments that you guys are now looking at more kind of the ones not as much related to the balance sheet or like the goods and services that to the banking companies. And I know you can't provide specific examples that you're examining, but maybe just expand upon what part of the capital structure you'd be investing? And – or what form those investments would take? If they would be different, than kind of, your traditional bread and butter preferred and sub debt deals?

Sure. I'll take a shot, Josh. You can take a shot. This is George Shilowitz. I think that it's actually interesting and its related to the issue of, for the gentleman before we're speaking about lower growth – loan growth, they're just not seeing massive amounts of it and that people are also contemplating that there could be some earnings issues or losses, credit issues in the future, not of great magnitude. But when you look at what's happening to equity prices, equity prices are off considerably and it's reflecting both the concern about credit as well as the sort of lackluster earnings. So what becomes interesting to us is that, while sub-debt maybe extremely well bid, because it's a plain vanilla instrument that qualifies for a lot of insurance companies and they have sort of too much money, which compresses the yields go lower because there's too much money and very low issuance. But that doesn't mean that banks actually aren't issued in core capital, equity capital. So they're not interested in issuing stock at low prices. So what comes into play are different ways of actually creating equity for the banks. So what is interesting to us and what we are pursuing is in our pipeline are regulatory capital place where it may typically is with a little bit of a larger bank, not a mega bank, but larger banks. Small community banks aren't sophisticated enough to do it, and don't typically tap equity in the capital market. So there, banks are actually willing to pay us rate. It comes in the form of structured notes, which really for them frees up capital. They're willing to pay the interest if – because on an after-tax basis, it's far, far cheaper than an equity issuance at these little valuations. So those are not off-the-shelf transactions. We think that they're – and they come into vogue in markets and dynamics like this where credit spreads are tight and equity prices are off. So cyclically, we actually like the landscape.

And to your point George, these aren't rating agency rated notes and hence the insurance companies don't have a way to hold this additionally.

That's correct. So we like to actually go where insurance companies, for example, really do not have firm footing where they can just to volume, and that's actually not that hard to avoid.

Got it. Thanks for the color. But speaking more, I guess, towards the nonbank investments, or like the goods and services provided to the bank companies or kind of fintech space that you guys have brought up on the last call. And the new opportunities that are in kind of the companies that can – that serve the banking sector that are relatively new or at least maturing at this point a little bit more solidified. If there would be the opportunities in that space, those would be of a different capital structure. What form of investments those would take? And if they'd be different than kind of a typical bank investments that you guys do?

By definition they're going to be different than the typical bank Investment. If you're investing in a corporate, which we as a firm have quite a bit of historical experience, you're going to take a very different approach than doing a regulatory capital investment, and that is just how a bank's looking at it. So typically when you're going to make an investment or a loan to corporate, unless you're doing private equity, you're going to try to be senior in the capital structure, right? If not the most senior. Or you might have something that has warrants or convertible rates, so that if it's a better result, you get to participate more in the upside and if it's not as good a result, you have the protection of being more senior. So the structures are going to be very bespoke depending on the situation. Now that said, I mean we saw a transaction that came in, without going into details, about 1.5 week ago, private equity firm looking at a services company that provides software about well over 1,000. I don't want to be so specific, well over 1,000 banks. And it's a buyout transaction. And that private equity firm was sort of having a chat with us to explore whether we could finance part of that to make it more efficient. Now this private equity firm is a very white-shoe private equity firm. We have a lot of respect, and to be senior to them is a pretty good place to be, because they don't like to lose money and they rarely do. And so in that kind of a case, we might be the senior financing alongside that buyout, which stretches their dollars further and gives us the protection of having a grade A private equity firm…

Great. That's helpful. Thank you. And then just one last one, I know you guys have one, spoken about it, and two, made an effort in the past couple of years and are again making one this year on the proposal for shareholders to turning to a Delaware trust. Can you just go over maybe what the advantages are for that? And what type of savings there could be? And if you have any transparency on that process, et cetera?

Sure, happy to go through it. It's actually very simple. There is no benefit. It is a check-the-box choice in Delaware between a corp and a trust. The benefit we get is $90,000 of tax savings every year. And with the opinion of two different law firms, there is zero downside. Just a check-the-box status, but we can't check the box without 50.1% of the shareholders voting. It's – we're doing with small interface. It's that simple. It's just crazy we can't get enough votes, not yes votes, just can't get enough votes when we go out for the proxy. So please people, if you're listening, vote, right? It's an immediate benefit to shareholders. All they have to do is say yes to this provision, and we will check the box in Delaware and be able to pass $90,000 a year back to our shareholders.

Which is about $0.003 on a quarterly basis, so it's something, it's something...

It's real money.

Yes, it's real money.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to management for closing remarks.

Thank you, operator. As always, thank you for listening. We appreciate your support and the time you take to understand our company. And we look forward to speaking with you soon. Have a great summer.

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