BCP Investment Corporation (BCIC) Q4 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the KCAP Financial, Inc. 2012 Earnings Conference Call. An earnings press release was distributed on Friday, March 15, 2013. If you did not receive a copy, the release is available on the company's website at www.kcapfinancial.com in the Investor Relations section. [Operator Instructions] As a reminder, this conference call is being recorded, Monday, March 18, 2013. This call is also being hosted on our live webcast which can be accessed at our company's website, www.kcapfinancial.com, in the Investor Relations section under Events. In addition, if you'd like to be added to the company's distribution list for news events, including earnings releases, please contact Denise Rodriguez at (212) 455-8300. Today's conference call includes forward-looking statements and projections and we ask that you refer to the KCAP Financial's most recent filings with the SEC for important factors that would cause actual results to differ materially from those projections. KCAP Financial does not undertake to update any forward-looking statements unless required by law. I would like to introduce your host for today's conference, Mr. Dayl Pearson, President and Chief Executive Officer of KCAP Financial. Mr. Pearson, you may begin.

Good morning, and thank you all for joining KCAP Financial for a review of our 2012 annual results as well as a discussion of our fourth quarter 2012. I will open the call with some broad commentary about important highlights and activities during the year, including the performance of our Asset Manager Affiliates and our principal investment portfolio. I will then turn the call over to our Chief Financial Officer, Ted Gilpin, to provide a recap of our fourth quarter operating results and our financial condition at the end of the year. We will then open the line up for your questions at the end of the call. First, let me provide a brief recap of some important highlights from the year. In the fourth quarter of 2012, our NII increased from $0.27 in the third quarter to $0.28. Our dividend increased from $0.24 to $0.28. Year-over-year, NII increased from $0.69 in 2011 to $0.93 in 2012, and our dividend increased from $0.70 in 2011 to $0.94. 2012 was a transformative year for KCAP. In February, we completed the acquisition of Trimaran Advisors, which increased the AUM of our Asset Manager Affiliates by almost 75%. More importantly, because of the operating leverage inherent in the Asset Management business, the cash flow available for distribution to KCAP increased significantly, contributing to the increase in our NII and our dividend. More important to long term for KCAP, the acquisition was essential to our ability to grow the Asset Manager Affiliates internally with new funds. That was borne out when we successfully completed a new CLO fund in December, which added an additional $400 million to AUM. Our Asset Manager Affiliates are currently warehousing for another CLO, which we hope to complete in the second quarter of 2013. As we mentioned on our last call, we also realized incentive fees from 2 of the CLO funds managed by our Asset Manager Affiliates in the fourth quarter. The incentive fees will grow and could significantly increase the income available for distribution to us beginning in 2013. I will now review our portfolio of principal investments and our new origination activity. Deal flow in the middle market lending business was good in 2012. We reviewed over 100 new deals. In addition, in November, we hired Jeff Knopping to spearhead and enhance our origination effort. Jeff is an experienced middle-market lender. In the fourth quarter, we closed 4 new investments totaling approximately $28 million, including our new -- our investment in the new CLO fund. One of these was a second lien investment that we lead and syndicated a portion of the loan. We also had significant repayment activity in the fourth quarter, which totaled over $30 million. To date, in the first quarter, we have funded approximately $40 million of loans and 5 new transactions. We also have one loan that paid off. We expect one other loan to fund this week for $5 million, and our current pipeline includes over $10 million of other loans that we believe have a reasonable chance of closing in the next 45 to 60 days. Given the uncertain economic environment and volatile credit market, we have remained very cautious in terms of deploying capital and continue to maintain adequate liquidity. The combined yield on our total debt portfolio was 22% at December 31, 2012. As of December 31, 2012, our weighted average mark-to-market value to par on our debt securities portfolio was 81 compared to 84 for the year ended 2011. As for our CLO portfolio, our weighted average mark-to-market value to par was 78 as of December 30, 2012, an increase from the weighted average mark-to-market to par of 63 at year end 2011. Our 100% ownership of our Asset Manager Affiliates was valued at approximately $77 million based on their assets under management and prospective cash flow. Our investment portfolio at year end of 2012 totaled approximately $312 million. Looking at the composition of that portfolio, our portfolio quality continues to hold up well. At the end of 2012, our debt securities totaled approximately $111 million and represent 35% of the investment portfolio. First-lien loans now represent 40% -- sorry, 54% of the debt securities and second-lien loans now represent 30%. Approximately 14% of our debt investments are fixed-rate investments with a weighted average yield of 11%. At December 31, 2012, we had 5 issuers on nonaccrual status, representing less than 1% of total assets. All CLOs managed by KDA and Trimaran continue to be current on equity distributions and management fees and as I said, some are now paying incentive fees. The stable income stream for our Asset Manager Affiliates allows them to make periodic distributions to us in the form of a dividend. In the fourth quarter, there was a distribution of $1,750,000. After that distribution, we had over $1 million left undistributed at the Asset Manager Affiliate level. Additionally, as of December 31, 2012, our Asset Manager Affiliates had approximately $3.6 billion of par value asset under management. We continue to evaluate equity and debt financing options, which will allow us to focus on continued balance sheet growth, increasing net investment income and dividend distributions. On October 4, 2012, we priced an unsecured senior note offering of $36 million with a coupon of 7.375%. The underwriter subsequently exercised the green shoe, which resulted in KCAP receiving total gross proceeds of $41.4 million. The proceeds will be used to further grow our loan and securities portfolio. On February 14, 2013, we completed a public offering of 5,232,500 shares of common stock, which includes the underwriters' full exercise of their option to purchase up to 682,500 of common stock at a price of $9.75 per share, raising approximately $51 million in gross proceeds. In conjunction with this offering, we also sold 200,000 shares of common stock to a member of the Board of Directors, Dean C. Kehler, at the price of $9.31 per share, raising approximately $1.9 million in gross proceeds. As of March 15, 2013, the closing price of our common stock was $10.40. And now, I'll ask Ted Gilpin to walk you through the details of our financial performance. Ted?

Thank you, Dayl, and good morning, everyone. Well, I'll first cover some high-level financial information and then go into a little more detail on specific metrics. As of December 31, 2012, our NAV stood at $7.85 per share, up from $7.82 at the end of September of 2012 and flat to December 31, 2011. One more comment on the NAV, the fourth quarter NAV is understated due to a dividend payable that occurs every year end. If we adjust for this dividend payable, NAV would have been $8.13 per share. As Dayl mentioned, the company declared a dividend of $0.28 for the fourth quarter of 2012 as compared to $0.24 for the prior quarter and $0.18 for the fourth quarter of last year. The increase over the periods can be primarily attributed to the full integration of Trimaran Advisors into our CLO Asset Management platform. The component pieces of net investment income, or NII, can be found at our operating results for the 2012 fourth quarter. First, interest income on our debt securities for the 3 months ended December 31, 2012, was $3.8 million or $0.14 per share compared to $2.6 million and $0.11 per share for the same period of 2011. The increase can be attributed to more invested average assets. Second, dividends from the investments in CLO securities were $5.8 million or $0.22 per share in the fourth quarter of 2012 compared with $3.8 million and $0.17 per share in the same period in 2011. The majority of the increase can be attributed to the acquisition of the equity in 4 Trimaran CLOs. And finally, the third revenue component, as stated earlier, our Asset Manager Affiliates dividended up to KCAP Financial $1.8 million or approximately $0.07 per share in the fourth quarter of 2012 as compared to $750,000 in the fourth quarter of 2011 or $0.03 per share. The increase resulted from our acquisition of Trimaran Advisors earlier in 2012, and the respective net asset -- or the respective assets -- net asset management fees available to be dividended up to us. Something to note, we do not always dividend up all that is available from our Asset Manager Affiliates. In fact, the Asset Manager Affiliates earned $2.8 million of distributable income in the fourth quarter and we dividended up $1.8 million of that. These 3 revenue components resulted in total investment revenue of $11.3 million as compared to $7.1 million for the same 2011 period or an increase of 59%. This increase was slightly offset by the fact that total expenses for the quarter year-over-year increased by $1 million from $3 million to $4 million, resulting in our recording net investment income, or NII, of $7.3 million or approximately $0.28 per share versus $4.1 million or $0.18 per share in the same period prior year. Now I'll cover a few aspects in more detail. As I mentioned earlier, fourth quarter year-over-year investment income from debt securities increased to approximately $3.1 million -- or increased approximately $3.1 million, a 32% increase from 2011. This increase was due to an increase in the size of our average loan portfolio, which was $131.5 million for the 12 months of 2012 versus $109 million for the prior year, the increase of about 20%. The increase also is due to positive income relating to prepayments on some of our debt securities. Fourth quarter year-over-year investment income from CLO fund securities increased 47% or $6.7 million to approximately $21.1 million from approximately $14.4 million in 2011. This increase is due to the aforementioned addition of subordinate tranches of CLO fund securities acquired in connection with the Trimaran acquisition. The company recorded net realized and unrealized appreciation of approximately $7.2 million or $0.27 per share during the quarter ended December 31, 2012, as compared to net realized and unrealized depreciation of approximately $5.4 million or $0.24 per share at the same period of 2011. On the liability side of our balance sheet as of December 31, 2012, our debt outstanding was $101.4 million, consisting of $60 million of convertible notes with a 5-year term and a fixed rate of 8.75%, and $41.4 million of senior notes with a 7-year term and a fixed rate of 7.375%. At year end, we had sufficient liquidity in cash and higher liquid investments to meet our credit and underwriting projects. And our asset coverage ratio at quarter end was 305%, which was well above the minimum required 200% for BDCs. For additional information regarding the above metrics and for full third quarter or for -- sorry, for full year 2012 results, please refer to the company's website or the SEC at -- and/or www.kcapfinancial.com. With that, I'd like to thank you for your time, and we'll now turn the call back to the operator to start the Q&A session.

[Operator Instructions] Our first question comes from John Stilmar of JMP Securities.

Just real quickly, just to start with the first line item in the income statement this quarter. It was a little bit higher than I thought, was wondering what drove that. Obviously, you've been very opportunistic in investing in higher-yielding securities. But curious if you could kind of break down for me how much of the interest income from debt securities was from incentive fees? And then, what kind of the average yield was for the quarter? I'm trying to segregate maybe some temporary benefit versus how far along you are on that larger portfolio rotation, which is clearly a tailwind for you.

Well, I guess, by incentive fees, you mean make wholes or prepayment penalties, is that what you're...

I apologize. Yes, that's exactly what I mean.

Do we have an exact number on that? It's...

It was...

In the quarter. We had 2 loans that paid off.

Approximately $1 million or -- $1 million I think, pretty close -- I'd have to look it up [ph].

Then it's somewhere around $1 million. I think it's less than $1 million. There were 2 that had significant prepayment penalties.

Okay. So a little bit less than $1 million. And then secondly, what -- do you have a weighted average yield for the quarter or -- on just the debt investments?

On just the debt investments, I believe it's around 7.5%.

Okay, great. And then transitioning to the Asset Manager, obviously, you only dividended up just a fraction of what it made. How much of their revenue came from the incentive fee and how much of it -- because it seems like there's a couple of puts and takes here. Wondering if you could kind of give us a little bit more clarity. Clearly, you have a big tailwind again of incentive fees, but how much of -- but you also closed a securitization or a CLO in the fourth quarter. Was wondering if you could kind of give us a little bit of how we should start thinking about this line item with both of those positives kind of flowing through in terms of how much we should be putting in our models for expectations of dividending up for the Asset Manager.

Yes. We had approximately -- a little under $900,000, I guess, of incentive fees that were booked in the fourth quarter of 2012. And as Dayl said, that was on -- 2 funds began paying, some didn't pay for the full quarter.

Yes, one of them was a small stub piece. I think one was sort of a full quarterly payment.

Right. So we would obviously expect that to start growing and we would realize full quarter's worth on those incentive fees. And then we expect that some of the other funds to reach their incentive fee payment some time in the next couple of quarters. So we're not giving exact guidance on what that amount will be, but you should obviously expect that to grow. And as it relates to the new transaction, you don't see much of that. It closed late in the fourth quarter, if any. And you'll see a little bit of that in the first quarter. It doesn't really kick in and start throwing off a lot of full cash until June, so...

Yes, one of the sort of things you have to keep in mind is when you make a CLO equity investment in a new fund, the first payment date isn't for 6 months. And that is very often a relatively small payment because your -- the ramp and then the fees that come out of that payment. So you really don't start seeing the full positive impact -- we won't see the full positive impact for KCAP until the third quarter payment from the new fund.

And should we assume just a 100% operating -- or nearly 100% operating leverage at 50 basis points on the amount the CLO falls through to the bottom line of the Asset Manager, give or take?

There's going to be some leakage there. I think that's probably too aggressive. We have grown the platform a bit. We have a couple analysts since the closing of that fund. So I think for funds going forward, that may be more the case. So this fund, it's probably more like certainly less than 50 basis points.

Okay, great. And then finally, just in terms of fair value. Noticed that you -- if my math is correct for the quarter, you guys wrote up the -- your CLO investments as well as the affiliate -- or as well as your investment in the Asset Manager. Can you walk through whether those are kind of a result of sort of the external environment, meaning the comps themselves improved or whether there's a fundamental difference in cash flows or whether the dread up in the Asset Manager was driven by the fact that the deal got done, so therefore, we should expect, given your valuation approaches, that you're only giving credit for deals when closed. Wondering if you could kind of break apart sort of fundamental actions versus relative value as terms of the drivers of those?

Yes, John, I'll handle the Asset Manager first. I mean, obviously, it's up due to the closing of a new transaction. So there's a bunch of component parts. First of all, we value the Asset Manager on 4 different metrics. One would be its cash flows, discounted cash flow. The other would be on comps in the marketplace, one would be on a multiple of assets under management and one would be on sort of an enterprise value bases. And I would say, for the most part, all of those were up a little bit. The cash flows, obviously, are most impacted by the new deal and they get all modeled in for that very specific deal. The reason it probably didn't go up as much as the cash flows were worth on that one deal is because we also -- new deals nowadays don't get structuring fees and those kind of things, which we took out of the model. We don't expect to get them anymore. So I would say that primarily was up because of the new transaction. And any time we'll close a new transaction, depending on the timing of that and the economics of that, that will -- should increase the value of the Asset Manager. As it relates to the actual CLO equity securities, that's driven sort of by the strength of the continuing cash flows, what the metrics of the deal themselves have been, what we expect the defaults are going forward, what we've been able to reinvest in and what the spreads are, where LIBOR is and all those other things. But it's also off of where that market is. Old CLO equity has been trading up, so that's really why the value of that has been going up and that's really where you see the value driven on those.

Perfect. And then just real quick housekeeping item. Can you just give me for the quarter the weighted average basic and diluted share count if you have that? Or we can follow-up offline.

Yes, I can give you the...

If you can hold on one second, I will give it to you. It is...

It's okay, guys. I'll follow-up with you.

Yes, it's...

No, it's going to be -- you're going to see it when the K comes out.

Yes, the K is coming out, fairly shortly anyway. But it was about $26 billion, 400-and-some thousand.

And that was obviously before the offering we did.

And you will see both the diluted table, which -- we give you fully diluted, which would be the convert shares, which is a complicated formula, and the other is our basic and our normal diluted is not that different because we don't have that much -- there are very few options outstanding.

Our next question comes from Ryan Lynch of KBW. Ryan Lynch - Keefe, Bruyette, & Woods, Inc., Research Division: You guys raised approximately $50 million of equity in this quarter, which kind of reduced your on balance sheet debt to equity. So I would assume that your next capital raise would be in the form of debt to accompany this equity raise. Can you guys kind of talk about your views on the different sources of that debt capital like baby bonds, credit facilities or convertible debt?

Yes. I think as you know, Ryan, we're always sort of looking at different ways of raising capital. We did the convert, we did the baby bonds, we did the share issuance. My guess is the next thing we're going to do is probably going to be somewhat debt-related. We are not finalized yet, but we're working on another sort of debt financing mechanism, which we would hope to close in the second quarter. But that's probably the most likely thing we'll do next. But we're always evaluating it both -- on both sides. We do not want -- as we've talked about, we want to keep our leverage and sort of that tapping out at sort of 0.65x to 0.75x, so that's our target high point leverage, so...

Our next question comes from Sam Hayes of Harvard Business.

I'd like to ask you to review how the different components of the portfolio would behave both with respect to income generation as well as asset valuation in a rising interest rate environment that we are lucky to have in the next several years?

On the asset side or both the assets and the liabilities?

Well, I'd like to hear on the assets side particularly, but I would like to also hear the liability side.

Yes, I think we're very concerned about rising interest rates, I think, which is one of the reasons we've tried to do some long-term debt financing to lock in fixed rates for a significant period of time. In terms of our debt portfolio, in terms of rising interest rates, you won't call it -- at some point, you'll start to see a benefit from that. Most of our floating rate loans, and most of what we have is floating rate, as we talked about, do have LIBOR floors ranging from 1% to maybe 2%, I think, in the highest case. So a rising LIBOR won't necessarily benefit the company, short term. But obviously, the more it rises, the more benefit we'll have in terms of income coming in. In terms of the CLOs, again, those are pretty -- they're all floating rate assets and floating rate liabilities. What you will see from time to time are timing differences as rates move because obviously, rates reset on the assets at different times and the rates reset on the liabilities. It's sort of hard to know how that's going to impact us quarter to quarter because it's going to depend upon when the rates go up and when certain assets reset, but it really shouldn't have a significant impact on our CLO portfolio. Ted, do you have any other thoughts on that?

That's fine.

Valuation-wise, would you expect the mark-to-market valuations of the assets to rise, in rough approximation, to the increase in the income that would be generated by the floating rate?

No, I think, again, the asset valuations are best based upon spreads of risk assets to riskless assets. So those valuations are going to be driven more by the changes in spread than by the rising of the interest rates.

I see. Okay. And on the fund source side, the liabilities side, you have -- you've locked in some interest rates in your recent fund raising. But how would you describe generally your exposure on the funding side?

Yes. What we -- I mean, right now, our -- both our debt pieces are fixed rate, so...

But we will have a mix going forward of fixed and floating rate. But I think we're going to be opportunistic and see not be too dependent on one or the other.

[Operator Instructions] Our next question comes from J.T. Rogers of Janney Capital Markets.

I guess you're talking about looking to close a new CLO potentially before the end of the second quarter. Sort of what's your all's [ph] capacity is for putting together new funds and how receptive do you think the market is where we are right now?

Well, today, I think the market is receptive. It's all a function of relative spread between the assets and the liabilities. I think early in the first quarter, the asset spreads tend to tighten before the liability spreads. I think you're starting to see the liability spreads come down a bit now, so deals are getting done. In terms of our capacity, given where we are in terms of staffing and everything else, it's really going to be a function of the market more than it is our capacity to do new deals. I think as you know, J.T., whether you have $1 billion of AUM or $4 billion of AUM, that you're probably not going to have that many more borrowers to follow, you're just having more spread across more funds of some of the same loans, so -- which is why we think there's a lot of leveragability still on that platform from here.

Okay, great. And then I guess on -- I know it sounds like it's just -- it's really going to be a function of the market and...

Yes.

Great. And then how much of the equity do you expect to be holding in new deals?

Of the equity tranche, less than 25%.

Our next question is a follow-up from John Stilmar of JMP Securities.

Just one quick follow-up, guys. By my simple math, it looks like at least from deals that you've closed in kind of quarter or middle market loans, it looks like it was about $50 million so far in the first quarter, if my math is correct, if I heard you. Could you give us an indication? I assume that what you'll be doing is rotating kind of your lower-yield senior lending loan assets and more of the proprietary originated kind of second-lien senior unsecured type investments? If that's true, can you give us a flavor for how much yield tick up we might be getting be getting in the first quarter?

That's going to be tough to do, I think.

While he noodles that over, I mean, I'll answer your prior question for you, John, which is on shares. Our basic shares at the quarter end were 26,433,753, so -- 26,433,753. If you dilute that for options, it's 26,451,667. But on a statement of operations what you'll see is they use weighted average. Our weighted average basic is 26,011,517, and if you fully dilute for the convertible securities, which I think is what you're looking for, it's 33,379,594.

Yes, I mean, I don't really have a specific answer to your earlier question, John. I think that comes too close to sort of giving a type of guidance we don't give, other than the fact that, I will say, some of the new origination activity is related to the potential credit facility we're looking at, which has a focus on middle market, first-lien loans, which obviously, have a significantly higher spread than broadly syndicated first-lien loans and as such, are going to be more attractive than the first-lien loans, which we would be moving out of.

Is it fair for us to kind of think about just the second-lien -- the core middle market asset itself having a kind of a L700, L800-type second -- generic second-lien kind of pricing?

The second liens are the ones we're looking at. The true middle market second liens are more like a 10% all-in yield, 9.5% to 10.5% all-in yield. The middle market first liens are generally in the sort of 6% yield range. That includes LIBOR floors and everything else.

[Operator Instructions] And at this time, I'm not showing any further questions, so I'd like to turn the call back to management for any further remarks.

Thank you all very much for joining us and we look forward to talking to you on our next call when we're talking our first quarter results. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, you may all disconnect. Everyone, have a great day.