BCP Investment Corporation (BCIC) Q2 2013 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the KCAP Financial Incorporated Second Quarter 2013 Earnings Conference Call. An earnings press release was distributed today, August 6, 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 is being recorded today, Tuesday, August 6, 2013. This call is also being hosted on a 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 would 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 could cause actual results to differ materially from these projections. KCAP Financial does not undertake to update its forward-looking statements unless required by law. I would now 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.

Thank you, and thank you all for joining KCAP Financial for a review of the second quarter 2013. I will open the call with commentary about important highlights and activities during the quarter, including the performance of our asset manager affiliates and our principal investment portfolio in detail. I will then turn the call over to our Chief Financial Officer, Ted Gilpin, for him to provide a recap of our second quarter operating results and our financial condition at the end of the quarter. We will then open the line for your questions at the end of the call. First, let me provide a brief recap of some important highlights from the quarter. In the second quarter of 2013, our NII decreased from $0.24 in the first quarter to $0.20. Our dividend remained at $0.28. There were several reasons for this decline including the conversion of approximately $9 million of our convertible bonds into additional shares, slower-than-anticipated investment activity due to frothy credit markets through much of the quarter and our unwillingness to increase the risk profile of our balance sheet in order to substantially increase our overall yield. Aggressive credit markets also contributed to a greater-than-anticipated paydowns in some of our older CLO funds and overall yields, lower yields on new assets. We continue to invest prudently and have been a somewhat better -- and have seen a somewhat better market since the early June of this year. We will not take undue risk in order to increase short-term results. In June, we closed on an on-balance sheet debt securitization of approximately $155 million to provide additional leverage for our core middle market lending business. On June 27, our asset manager affiliate closed on Catamaran 2013-1, a new CLO fund. KCAP invested $9 million in the junior tranche as part of our overall CLO investing strategy. Our asset manager is currently in discussions regarding its next CLO fund, which we anticipate pricing before year end. I will now review our portfolio principal investments and new origination activity. On the direct origination side of the business, we have been busy pursuing new middle-market lending opportunities. Year-to-date, we reviewed over 262 new deals. We have completed 23 new deals totaling $92.3 million of new core investment since the beginning of the year, including a $9 million investment in the new Catamaran CLO fund. Given the uncertain economic environment and the volatile credit market, we remained disciplined in our investment strategy, deploying capital in a manner that allows us to maintain significant liquidity. The combined yield on our debt portfolio loans, bonds and CLO securities was 16% on par and 18% on fair value at June 30, 2013. As of June 30, 2013, our weighted average mark-to-market value to par on our debt securities portfolio was 89 compared to 87 for the first quarter of 2013. As for our CLO portfolio, our weighted average mark-to-market value to par was 71 as of June 30, a decrease in the weighted average mark to par of 74 for the first quarter of 2013. Our 100% ownership of our asset manager affiliates was valued at approximately $87 million based on their assets under management and prospective cash flows. Our investment portfolio at the end of the second quarter totaled approximately $436 million. Looking at the composition of our investment portfolio, our portfolio quality continues to hold up well. At the end of the second quarter of 2013, our debt securities totaled approximately $191 million and represented about 44% of our investment portfolio. First-lien loans now represent approximately 50% of the debt securities and junior loans now represent 20%. Approximately 11% of our debt investments are fixed-rate investments with a weighted average rate of approximately 11%. As of June 30, we had 5 issuers on nonaccrual status, representing less than 1% of total assets at fair market value. All CLOs managed by KDA and Trimaran continued to be current on equity distributions and management fees, and 4 of the funds will pay incentive fees in the third quarter, up from 3 funds paying fees in the second quarter. 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 second quarter, there was a distribution of $3.3 million. Additionally, as of June 30, 2013, our asset manager affiliates had approximately $3.7 billion of par value assets under management. And now I'll ask our CFO, Ted Gilpin, to walk you through the details of our financials.

Thank you, Dayl, and good afternoon, everyone. I will first cover some high-level financial information and then go into a little more detail on specific metrics. As of June 30, 2013, our NAV stood at $8.24 per share. This compares to $7.85 at the end of December 2012. The increase can be attributed to issuing shares above NAV in the first quarter and to a dividend payable at the year end of approximately $7.4 million or the equivalent of $0.22 per share based on the common shares outstanding at June 30, 2013. The company declared a dividend of $0.28 for the second quarter of 2013, the same as the prior quarter and compares to $0.24 for the second quarter of last year. The component pieces of the dividend can be found in our operating results for the 2013 second quarter. First, interest income for the 3 months ended June 30, 2013, was $3 million or $0.09 per share, as compared to $2.7 million and $0.10 per share for the same period of 2012. Second, dividends from investments in CLO securities were $4.9 million or $0.15 per share in the second quarter of 2013, compared with $5.5 million and $0.21 per share in the same period of 2012. The majority of the decrease can be attributed to the paydowns in existing CLOs that have passed their reinvestment period. This was partially offset by incentive fees paid through our asset manager, as well as the addition of the Catamaran 2013 CLO, which closed at the end of June. And finally, the third revenue component of the dividend from our asset manager affiliates was $3.3 million or $0.10 per share in the second quarter of 2013, as compared to $1.2 million in the second quarter of 2012 or $0.04 per share. The increase resulted from our acquisition, again, of Trimaran earlier in 2012 and the respective net asset management fees, including incentive fees available to be distributed up to us. Assets under management stood at $3.7 billion at the end of the second quarter as compared to $3.4 billion in the second quarter of 2012. These 3 revenue components resulted in total investment revenue of $11.2 million for the quarter ended June 30, 2013, as compared to $9.5 million for the same 2012 period. Total expenses year-over-year increased $1.2 million to $4.7 million, compared to $3.5 million during the same period in 2012. Of the $4.7 million of expenses, $2.3 million related to debt expense increased from [ph] approximately $600,000 over the same quarter in the prior year. The balance of the increase relates to an increase in professional and administrative fees. We recorded net investment income or NII of $6.6 million, or approximately $0.20 per share, as compared to $6 million or $0.23 per share for the same period in 2012. Now I'll cover a few aspects in more detail. As I mentioned earlier, second quarter year-over-year investment income from debt securities increased 12.2% or $300,000 -- approximately $300,000 to $3.0 million from $2.7 million in the prior year's same period. Second quarter year-over-year investment income from CLO fund securities decreased 11% or $600,000 to approximately $4.9 million from approximately $5.5 million in 2012. This decrease is due to the aforementioned paydown from CLO positions that are out their investment period. The company recorded net realized and unrealized depreciation of approximately $1.9 million or $0.06 per share during the quarter ended June 30, 2013, as compared to net realized and unrealized depreciation of approximately $4.4 million or $0.16 a share for the same period of 2012. On the liability side of our balance sheet, as of June 30, 2013, our debt outstanding consisted of $51 million of convertible notes for the 5-year term and fixed rate of 8.75%, $41.4 million of retail notes with a 7-year term and a fixed rate of 7.375%, and $105 million in secured borrowings with a weighted average rate of 2.55%. Our weighted average borrowing rate is now 5.16%, down from 8.19% at the end of December 2012. At quarter end, we had sufficient liquidity in cash and highly liquid investments to meet our credit and underwriting projections. Our asset coverage ratio at quarter end was 239%, which is above the minimum required 200% for BDCs. For additional information regarding the above metrics and for full second quarter 2013 results, please refer to our recently filed first -- second quarter 10-Q available online at the SEC, www.sec.gov, or on our website, www.kcapfinancial.com. With that, I would like to thank you for your time. We will now turn the call back to the operator to start the Q&A session. Operator?

[Operator Instructions] Our first question is from Mickey Schleien of Ladenburg. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: I wanted to first understand -- there was a lot of information that you just gave us. I want to make sure I understood. The dividends from the affiliated asset manager, is the $3.3 million that you accrued in the quarter sort of a run rate that we can expect or is there a timing issue there?

No, I think we said -- it's Ted. We said in the first quarter, the run rate is approximately $3 million per quarter. That can be up and down depending on what incentive fees we actually receive. So it was a little bit higher this quarter. So we expect that to be -- to keep in that range of around $3 million. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Okay, and in terms of the payable for open trades, I'm assuming most of that has to go into relatively liquid leverage loans, would that be correct?

No, that includes a number of loans that we entered into commitments right around the end of the quarter. Some of those are some liquid loans that we use as placeholders, which I didn't include in sort of the core assets I talked about. But a lot of those relate to some middle-market loans that we had committed to and -- but closed actually right after the end of the quarter. So it's a combination. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Okay, and what drove the markdown of the CLO investments? Is that just the math due to the end of the reinvestment period?

Yes, it's really the math. I mean, it's discounted cash flow. So when we receive cash flows, it comes down. And when they prepay, it comes down.

Yes, I think the real takeaway from the second quarter is that there was extraordinary amount of refinancing activity in the broadly syndicated loan market in particular. So there was a lot of unexpected prepayments in the CLOs and if they're outside of the reinvestment period, obviously, that has an impact. I think the third quarter we've seen that alleviate not completely but certainly sort of more normalized as you would expect, obviously, with the summer. So a lot of that was, I would say, somewhat unanticipated in terms of the paydown. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Okay, and given what you just said, Dayl, I'm having a hard time seeing how you're going to cover the dividend from NOI considering where the yields are now in these CLO investments?

Yes, well, I think couple of things to take away. First of all, we have an awful lot of liquidity right now, which we are continuing to invest. We've invested another $40 million or so since the end of the quarter. We obviously have a new CLO fund that we're going to be warehousing for what we hope at some point very soon. And I think that the board obviously is going to look at -- look forward in making a determination in terms of that -- the dividend. But we do have a lot of dry powder that was not invested, and what was invested in the second quarter tends to be invested fairly late in the quarter.

[Operator Instructions] Our next question is from Troy Ward of KBW. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Dayl, you mentioned that you had 3 securitization paying incentive fees in the second quarter and one more supposed to kick in the third quarter, can you give us kind of some guidelines on what that we can expect from that?

In terms of sort of the delta between the second quarter and the third quarter? Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Yes, and the timing, will it be a full quarter?

It will not be a full quarter. You won't really see that until the fourth quarter. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Right. And so more importantly, I guess, then what is the ultimate delta that we can expect for kind of an ongoing run rate?

It's going to be up, but some of the other fees will start to come down a bit. So it will be up somewhat, but I don't really -- it's too hard to know at this point. It's going to be a function of, again, refinancing activity and how quickly those funds start to -- continue or don't de-lever. So it could be up somewhat or could be relatively flat in the fourth quarter. Hard to tell at this point. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then on the new CLO that Trimaran did get done, have those fees kicked in, and if not, how much will that be and when will they kick in?

Yes, very little bit of those fees kicked in. We didn't really close the time [ph] . But I mean, in others words, we accrue for a piece [ph] so it's very little in the financials so it'll start to kick in the third quarter. It's when it really hits. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then Ted, you talked about the securitization cost at 2.55%, is that what -- is that fully loaded for any fees you had to take or is there some amount of amortization of fees on that when we do our modeling?

Yes, when you do your modeling, there's -- it's in the Q how much OID there is and then how much there's also underwriting fees. So the 2.55% is not with that.

But that's all in the footnote in the Q.

Yes, it's all in the footnote in Q. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then one final one, Dayl, can you speak a little bit about the conversion of the bonds in the quarter and kind of what -- how you view those outstanding and whether or not you have any insight into further conversion?

We don't really have a lot of insight in the further conversion. I mean, this happens sort of right after the interest payment date and right before the dividend payment date. So we sort of got a double whammy there. We paid both the interest and the dividend in March and April. And obviously, somewhat it adds more shares in the short term. In the long term, obviously, it adds to our equity account and it gives us more ability to add additional leverage. I think, as you know, we have the ability to upside the debt securitization facility to take advantage of the lower rate in that facility. So it does give us added flexibility, but obviously, in the short term, it has an impact because it puts a lot more shares out -- well, not a lot more -- it's about 1.1 million shares, Ted?

Yes, 1.1 or 2 [ph] million.

Yes, so it increased our shares by about 3%. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Okay, and then one final one on the nonaccrual side, I apologize we just don't have time to go through the Q when it hits that late before the call.

We apologize for being as late as it was. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: So you said you had 5 nonaccruals, was that a change quarter-over-quarter and was there any significant movements in the valuation of your nonaccruals this quarter?

No and no. Although I guess, we did get a payment in one of the nonaccruals, but it was after the quarter. There was a time [ph]. It was not a big amount. It didn't move the needle at all. It's the same 5 names, unfortunately, that we'd love to get them completely cleaned up and get them off the balance sheet, but they're still there.

Our next question is from Chris York of JMP Securities.

It seems prepayments continue to be a theme among BDCs that have reported this far. How are you guys thinking about additional prepayments in your existing CLO funds throughout the remainder of the year?

Well, as I said, I think the second quarter was a pretty -- we say the second quarter tends to be a sort of a high period for prepayments because people -- it's a very active quarter. It's a full quarter. People aren't constrained. In the first quarter, you're a bit constrained because you don't have year-end financials. In the third quarter, obviously, you have the summer hiatus. In the fourth quarter, you have year end. So it tends to be the seasonally somewhat higher than the other quarters for prepayments and obviously, it was a very, in our view, certainly in April and May in particular, a very frothy credit market with rates coming down and people's receptivity to dividend recaps much greater than it might have been. So I guess in the third quarter, we don't anticipate the same level of prepayments, but it's hard to know. It's a function of the market right now, and the market sort of sold off a bit in June, which happened to be advantageous as we were ramping as the asset manager was ramping Catamaran 2013-1 because they were able to buy assets in the secondary market at very attractive prices. But hard to know what the fall is going to be like. It's really -- that's probably a better question to ask in November because we'll have sort of a sense of how frothy the credit markets are after Labor Day. Right now, those have shut down a bit. So...

Sure, I understand. It's a tough question. I appreciate all your color on that. So help me understand what you saw during the quarter, or maybe provide me a little bit more color that caused you to attribute the shortfall in NII to the slowdown in investment activity considering that Q1 commentary included somewhat of a solid pipeline of deals.

Yes, we had a solid pipeline. We saw a lot of deals. I think what we discovered as the quarter went on is the quality of the deal flow was not as good as it was earlier in the year, although it has improved in the last month or so. But in particular in April and May, it was a pretty frothy period in the markets, and I think we saw both credit and pricing suffer. That's -- in the middle market, that's come back a bit. In the broadly syndicated market, maybe a tiny bit, but it's definitely gotten to the point where people are doing very aggressive things, and I think our view is we're going to be very cautious.

Let's see -- just going down on my list -- that investments in the defense sector have seen some negative marks this quarter and I guess, throughout 2013 year. Could you talk about fundamental that Hunter Defence, given that was written down about 5% from cost?

Yes, I think the company continues to perform decently. I think there was a mark [ph] out there that we took into account in terms of the valuation as we always do. But we don't -- underlying credit fundamentals of Hunter Defence haven't really changed that much.

Our next question is from Mickey Schleien of Ladenburg. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: So I want to just follow up on the comment about liquidity. When I look at your cash and your restricted cash and take into account the open payable for the trades you've already committed to and the receivable, we get to about $23 million. And obviously, you've got to leave some cash for working capital. So it looks like perhaps $15 million of liquidity barring some external capital, does that sound right?

It should be more than that. If I remember correctly, the restricted cash was $78 million, which essentially relates to the $67 million of payables. So that leaves you $11 million, and then there was another $67 million of marketable securities, which is effectively cash. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Fair enough. Okay. Now I understand better.

So there's a lot more. We've invested some of that and we obviously got to put certain amount aside for first loss for the next warehouse for the asset managers. But obviously, that's something that generates income as well. So -- but yes, we're always cognizant of that. So we probably at the end of the quarter had about $80 million of cash [ph] or more and now we probably invested another $40 million since then. So and we have maybe another $10 million or $15 million in process at this point that we're going to close on in the next couple of weeks. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Okay, and I just want to confirm...

And we saw a lot of liquidity. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Right, right. Now I understand what you're saying now about money market account. So I would just want to confirm what I think you said or what I heard was that the Trimaran CLO didn't close until the end of the quarter or almost at the end of the quarter. So the dividend that you received, the $3.3 million, really doesn't reflect much from the fees that are going to be earned on that, is that -- did I hear that correctly?

Essentially, we flagged [ph], I think, 2 days worth of fees because we closed on the 27th and the quarter effectively ended on the 28th, which was a Friday.

Right. It's not there. You'll pick it up in the third quarter but again, some of that will be offset by continued paydowns on the older securities. So one of the reasons to keep adding new CLOs. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Right, right. So the delta from dividends from affiliated asset managers of $300,000, that was due to incentive fees for the most part?

Yes, first and second quarter. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Between last year and this year?

No, no, from first to second quarter. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Oh, first to second.

Yes, it went from $3 million to $3.2 million.

Yes, I mean there was some of that significant amount, they came from incentive fees. So... Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Okay. And on the $400,000 -- $400 million CLO making some basic assumptions, I get to about $400,000 of additional fee income per quarter potential from the asset managers, is that in the ballpark?

Yes, from the one that closed at the end of the quarter, yes. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Okay. So we could end the year at 3.7-ish?

Yes, but again, you're going to have all the other assets are paying down. So depending upon how fast they come down, those fees will come down as well. And then obviously, if we get another one closed -- I mean the idea here is to add 2 to 3 funds a year. It will not only replace what's rolling off, but will actually grow the bottom line of the asset.

Our next question is from Troy Ward of KBW. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Just a couple of follow-ups. First, as I looked at the model, Dayl, can you talk to comp expense in the second quarter? It looks like it's always seasonally high. I'm assuming maybe that's when bonuses or something hit. And what can we expect for the second half of the year?

Well we did have some -- we did hire some new folks, and I think there was some amount of recruiting expense in that number.

Mostly, we had uptick in professional fees and administrative fees. Some of the professional fees were placement fees we paid. But generally speaking, it was -- we had dividend expense was up and then professional and our legal, accounting, recruiting fees were up. So... Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: So how should we think of the run rate for the tail half -- in the second half of the year as compared to this quarter?

Yes, I would say it should be fairly stable would be what I think it would be. It backed down a little bit.

It should be down a little bit. We did add one significant person, Jill Simeone, who's our new General Counsel and also the Chief Compliance Officer, and we're hoping that Jill will help us to also better manage our professional expenses, and particularly, our legal fees. Troy L. Ward - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then one final one, you talked about kind of quarter-to-date, I think you mentioned $40 million, with $10 million to $15 million kind of in process. What about on the prepayments side, how much activity you had there on the balance sheet portfolio and then also in the CLO funds?

I don't think there's been anything in the balance sheet portfolio since May, right? I'm looking at somebody here. Since May -- and on the CLOs, I don't think there's been a lot of prepayments since the end of the quarter, very little.

I'm not showing any further questions in the queue. I'd like to turn the call back over to management for any further remarks.

We thank you all for spending time with us today, and I apologize if the Q ended up coming out a little bit too close to the call. But we appreciate all your consideration, and we'll talk to you again soon. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may now disconnect. Everyone, have a great day.