BCP Investment Corporation (BCIC) Q3 2020 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Portman Ridge Finance Corporation Conference Call. An earnings press release was distributed Monday evening, November 9. If you did not receive a copy, the release is available on the company's website at www.portmanridge.com in the Investor Relations section. As a reminder, this conference call is being recorded today, Tuesday, November 10, 2020. The call is also being hosted on a live webcast, which can be accessed at our company's website at www.portmanridge.com in the Investor Relations section under Events. [Operator Instructions] Today's conference call includes forward-looking statements and projections, and we ask that you refer to Portman Ridge's most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. Portman Ridge Finance Corporation 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. Ted Goldthorpe, Chief Executive Officer of Portman Ridge Finance Corporation. Mr. Goldthorpe, you may begin.

Thank you, operator, and welcome, everyone. Thank you for joining us. Yesterday afternoon, we reported our third quarter 2020 financial results. I am joined today by my CFO, Ted Gilpin; and my Chief Investment Officer, Patrick Schafer. Ted Gilpin will provide additional detail on our financial results, and Patrick will do the same on the investment portfolio. I will begin by discussing Portman Ridge's performance for the third quarter and then speak more on the merger with Garrison Capital, which we closed on October 28. Overall, I am pleased to report that Portman Ridge had a solid quarter marked by a significant improvement in net realized and unrealized gains of $5.6 million across our entire portfolio. While we're clearly not out of the woods with respect to COVID, we experienced improved market sentiment during the quarter as portfolio companies began to gain a better sense of near-term financial visibility on their prospects. M&A and refinancing activity began to pick up after having been quiet in the prior quarter. Net investment income per share was $0.06, consistent with the past 4 quarters, and the distribution level we have set for the past several quarters. Net asset per share was $2.85, an increase of 5% from the net asset value per share of $2.71 as of June 30, 2020. Driving this increase in net asset value per share was a broad-based strengthening of our portfolio due to market spreads tightening throughout the quarter. M&A activity, which is a traditional source of middle-market direct loans, picked up substantially towards the end of the quarter. While still at depressed levels as compared to the last several years, we experienced buyers, sellers and lenders, all returning to market in an orderly fashion, and activity levels continue to pick up pace through the end of the quarter up to present day. Turning now to our merger with Garrison Capital, which we first announced on June 24 and subsequently closed on October 28. We believe this merger is a truly transformational event for Portman Ridge as it represents the continued execution of our vision of the consolidation in the public BDC space. It is the third strategic transaction successfully closed by our team in less than 2 years. We are very excited about the benefits this merger brings to the combined company. First, the merger results in significant added scale and size, essentially doubling the size of the company. At closing, the combined company held total assets of approximately $638 million compared to Portman Ridge total assets of $300 million as of September 30. As a larger company, we expect to -- we expect immediate savings related to overhead and public company expenses on a per share basis, and in the longer term, increased trading liquidity of our common stock and the capability and flexibility to speak for larger deals. Based on our previously discussed target leverage range of 1.25x to 1.4x, where we sit today, the pro forma Portman, we need to generate an approximately 9.5% to 10% return on its investment portfolio to cover our historical $0.06 per quarter distribution. Over the last 5 quarters, Portman has averaged 10.8% annual return on its investment portfolio despite the headwinds from LIBOR declining and reduced earnings from our CLO equity portfolio. Although these estimates are subject to change in the future, our historical ability to achieve returns on our investment portfolio in excess of what is required to sustain our distribution level should provide shareholders insight into earnings prospects going forward. Furthermore, we expect that leveraging the considerable resources, namely the access sourcing capabilities and industry expertise afforded by BC Partners across the entire platform, will be of significant benefits to all stakeholders of our combined company. Integration and repositioning efforts are already underway. As of this call, we have already sold approximately $87 million of assets originated by Garrison at a slight premium to the fair value at the time of the merger. Pro forma for the Garrison merger and these asset sales, Portman's leverage on a net cash basis, i.e., after the use of cash on hand to pay down debt once the debt becomes callable, is approximately 1.4x or regulatory asset coverage of approximately 169%. We will continue to opportunistically sell assets as part of our repositioning strategy, but believe that we have significantly reduced market risk to our portfolio in a very short period of time. Over time, our goal is to maintain a portfolio of directly originated senior secured debt investments with a focus on first lien investments, and we look forward to updating you on our progress in future quarters. With that, I will turn the call over to Ted Gilpin, our Chief Financial Officer, for a brief overview of the financial results; and then to Patrick Schafer, our Chief Investment Officer, for a review of our investment activity before concluding the call with some additional remarks. Ted?

Thank you, Ted. Good morning, everyone. As of September 30, 2020, our NAV stood at $126 million or $2.85 per diluted share, up 5% from last quarter of $120.7 million or $2.71 per share. The increase was mainly attributable to unrealized gains across our investment portfolio, including $4.6 million on our debt securities portfolio, $1.9 million in our legacy CLO equity positions and $1.1 million on our investments in the KCAP, Freedom 3 and BCP Great Lakes joint ventures. As Ted mentioned, we are beginning to observe improved market conditions, which resulted in the significant improvements in valuation. Net investment income for the third quarter of 2020 was $2.7 million or $0.06 per diluted -- per share as compared to $2.2 million and $0.06 per share in third quarter of last year. We have generated net investment income of $0.06 per share for the past 5 quarters, right in line with our current quarterly distribution. We announced our quarterly distribution of $0.06 per share on October 16 for shareholders of record on October 26 and to be paid on November 27. Following this distribution, we will resume our normal declaration and payment schedule. With respect to liquidity and unfunded commitments, our aggregate unfunded commitment stood at $26.5 million at September 30, 2020. However, only $2.4 million of this amount is subject to a unilateral draw right by the borrower and the remaining commitments are subject to certain restrictions, such as borrowing base, use of proceeds or leverage that must be satisfied before a borrower can draw down on the commitment. On the liability side of the balance sheet, we believe that we are in a relatively strong position and have meaningful investment and liquidity flexibility with relatively limited funding commitments. As of September 30, 2020, we had $77 million in 6.125% notes outstanding and $94 million in borrowings under our credit facility for a total of $171 million of debt. As of September 30, 2020, our debt-to-equity ratio was 1.36x. From a regulatory perspective, our asset coverage ratio as of September 30, 2020 was 172%, which is above the statutory requirement for BDCs of 150%. Under the stock repurchase program announced in March of 2020, we continued repurchasing shares this quarter and repurchased 358,959 shares of stock at an average price of $1.27 per share. We expect to continue to evaluate opportunities to buy back shares to further facilitate these opportunities. We entered into a 10b5 repurchase plan on August 31 of this year. As Ted Goldthorpe mentioned, we are very pleased to complete the merger with Garrison Capital this quarter. At closing on October 28, Garrison stockholders received a combination of $19.1 million in cash from Portman Ridge, and newly issued Portman Ridge shares valued at 100% of NAV. Garrison stockholders also received an additional cash payment of $5 million from our investment adviser, Sierra Crest. As a result, Garrison stockholders received per share of Garrison stock $1.50 in cash and 1.917 shares of Portman Ridge stock per share. Following closing, Portman Ridge shareholders owned approximately 59% of former -- and former Garrison stockholders owned 41% of the combined company. We are fully in process of integration and look forward to providing combined results next quarter. With that, I'd like to turn the call over to Patrick Schafer, our Chief Investment Officer.

Thanks, Ted. Turning to Page 9 of the slide presentation. The third quarter was relatively quiet for us, given where we plan to operate from a leverage perspective and preparing for the upcoming merger with Garrison. During the quarter, we made investments into 2 borrowers, one of which was into the BCP Great Lakes joint venture and the other of which was a brand-new borrower, which was completed alongside other BC Partners entities. In aggregate, these 2 investments totaled $4.7 million of face value, 62% of which was a first lien security and the remaining 38% being net add-ons to the Great Lakes joint venture. The weighted average spread on the new investment, excluding the Great Lakes joint venture that currently remain on our balance sheet, was 625 basis points. Additionally, over the course of the quarter, we fully exited 4 positions, one of which was a legacy nonaccrual OHAI position. In aggregate, our fully exited positions represented a carrying value of $9.4 million and resulted in a gain of approximately $65,000. All positions were sold either at or above their carrying value relative to June 30 or cost if it was acquired during the quarter. After adjusting for movements between unrealized and realized, we recognized approximately $5.6 million of unrealized gains on our portfolio. Our debt and equity securities accounted for an approximate $2.5 million unrealized gain while CLO equity positions accounted for a $1.9 million unrealized gain and our 2 joint ventures accounted for the remaining $1.1 million of unrealized gain. On an equivalent basis, as of September 30, Portman Ridge has $226.2 million of debt securities marked at 90.4% of par and yielding a stated spread to LIBOR of 715 basis points on accruing debt securities. This compares to $233.3 million of debt securities marked at 88.5% of par and yielding a stated spread to LIBOR of 681 basis points on accruing debt securities as of June 30, 2020, and $165.7 million of debt securities portfolio marked at a blended price of 91.9% of par and stated spread to LIBOR of 658 basis points when Sierra Crest took over management of Portman Ridge on April 1, 2019. Turning to Slide 10. Nonaccruals as of September 30, 2020, represented 3.2% of cost and 1.3% of fair value on the investment portfolio as compared to 5.9% and 3.7%, respectively, as of June 30. With that, I will turn the call back over to Ted Goldthorpe.

Thank you, Patrick. In closing, we are pleased with the results in the third quarter, especially in these difficult COVID times. The business environment certainly seems to be improving compared to conditions in March and the second quarter. However, we will continue to remain vigilant as the possibility of the second wave of COVID cases continues to loom over us. We are very pleased to have successfully closed the merger with Garrison and look forward to providing more updates on the combined company next quarter. I'd like to thank all of our shareholders for your ongoing support, and I will now turn over the call to operator for any questions.

[Operator Instructions] Our first question comes from Christopher Nolan with Ladenburg Thalmann.

What is the ending -- following the Garrison closing, what do you estimate the ending share count to be, please?

Sorry, Chris, I was on mute. We estimate the ending share count to be just under 75 million. I can give you the -- Patrick?

Yes. I believe it's 74,960 around.

Great. And I guess a follow-up on what -- given where BDC land in terms of valuations is sort of hovering these days, what are your strategic thoughts in terms of once you digested Garrison, further acquisitions? Or how do you plan to go forward from there?

I would say -- well, I'd say a couple of things. One is we continue to think the whole sector is cheap. So we're going to continue to buy back our own stock, and you'll see more of that, I think, this quarter. I think number two is, obviously, we're always on the lookout for additional things to add into our business, whether they're publicly traded BDCs or privately traded BDCs or other types of mechanisms. Because again, the benefits to our shareholders are just very compelling, and we've shown a track record of being able to derisk these transactions. I think it's -- we highlighted on the call, but when we closed the Garrison merger, we were 2x gross leverage, and we've got it down to 1.4x net in about 2 weeks. And so it's a very similar playbook to what we've shown. And so we've derisked the acquisition and executed on a lot of the integration synergies we talked about in a very short period of time. So we are always on lookout for it. But I would say these things are always hard to predict. And -- so we don't have anything imminent to announce, let's put it that way.

[Operator Instructions] Our next question comes from Paul Johnson with KBW.

You actually clarified one of the questions I wanted to ask, just to make sure I heard it right. But yes, 1.4x pro forma net leverage, that's I'm assuming after post-closing of all those asset sales? Was it $87 million or so that you mentioned?

Yes.

That's right. They take a little bit to actually settle, but yes.

Yes. Wind that up and closed it. And then there are some CLO liabilities that we've inherited from the transaction, which become callable imminently. So when those transactions settle, we'll be able to pay off debt. So that's the reason we quoted -- the reason we quoted it net is because we're waiting for these -- these transactions are off our books from a risk perspective, but haven't settled. And when they settle, we'll be able to pay down our -- some of our CLO liabilities.

Okay. Okay. And then yes, post closing that merger, that's obviously very positive improvement, very quick deleveraging you guys already completed there, which is very positive. But going forward, in the forward quarters, will the focus be to maybe first pay off some of those CLO tranches of debt? Or will you turn your attention maybe to some of the unsecured debt perhaps the -- I think the baby bonds that are due in 2022? Is there any sort of priority there level for the debt capital?

I think the priority sort of is to remove the CLO liability debt first, generally speaking. But yes, we're aware that the baby bonds are coming due. Would you like to have a mix of secured and unsecured? So there's a possibility that we'll go back into the unsecured market for that piece. But at the end, we'll probably have a blend between the secured and unsecured, but not be reliant on the on-balance sheet CLO debt.

Got you. And lastly, I just wanted to ask the higher dividend income this quarter from the JV, was that just more or less sort of a catch-up from previous quarter? Or was there anything specifically that drove a higher distribution this quarter?

You're pretty spot on. It got held up in the prior quarters. We weren't able to distribute as much as we normally do. We were able to do a catch-up this quarter. So I think if you sort of look across the last 3 quarters, that's pretty much at the steady state.

Got you. And one more, if I may, actually. Just kind of broadly speaking, from the beginning of the year, how would you characterize the depreciation, again, that's happened since the beginning of this year? The remaining depreciation about how much of that you think would be recoverable going into next year, I'm looking at, I think, approximately maybe $32 million in the first quarter of net depreciation. I think this quarter was a pretty significant write-up of 5.6% or so. Do you sort of look at that remaining depreciation as recoverable? Or how would you characterize that?

Yes, why don't I take the first crack at that. I mean, I think if you look at our average -- where our average debt is marked, we're still marked on a -- at a decent discount to par. So to the extent that we can continue to get nonaccruals down and we don't have any surprises, there is some embedded upside in our NAV. Just between now and when we're going to realize that NAV is hard to predict. And obviously, I think our -- I think we're pretty cautious going into next year about just what's going to happen, not speaking about our own specific portfolio, but just in general. So it's always hard to predict. But again, where our average debt piece is marked and where our CLOs are marked vis-à-vis their cost, a, we think we're conservatively marked, and number 2 is, if things continue to recover as they are, there should be some upside in our NAV. But again, I would -- we really are hesitant to provide any kind of guidance or forward guidance, just given the amount of uncertainty and change that's happening on a daily basis out there. Yes. I think the good news from our perspective is if you take a step back, we've been able to increase debt spreads pretty dramatically actually over the last 2 quarters. So LIBOR has been kind of like in our face. So that's been a negative. But we have been able to get additional spreads. And hopefully, those spreads will stay in our books for some period of time. And then number two is, you obviously saw the progress we made on nonaccruals this quarter. And the credit quality of our portfolio has actually improved over the last 6 months, and actually, we've seen some improvement this quarter as well. So again, hard to predict that trend continuing, just given everything happening out there. But I would say we continue to be encouraged from what we've seen on a trailing basis, let's put it that way.

[Operator Instructions] Our next question comes from Steven Martin with Slater.

A couple of questions. Can you talk in a little more detail about the CLO portfolio, where it is, what it went through? And where it was, what it went through and where it is today? And it didn't look -- I thought you guys would be running more of it off and at cost, it doesn't seem to be diminishing.

Yes. Ted or Patrick, do you want to address that? I can do address it as well.

Sure. Go ahead.

Yes. I mean, sorry, I didn't go [indiscernible]. I mean, talking about where it was to where it is now, I think when you look at our CLO equity portfolio, obviously, we're deemphasizing it and not continuing to invest. But we have -- the portfolio is split relatively evenly, I'll say, in terms of half of our positions are kind of out of their reinvestment period and half are still in their reinvestment period. And so as you think about where -- what happened during March and kind of where we are today, about half of the portfolio has been able to kind of take an active management rotate out of CCCs, buy assets at discounts and kind of generally refill their collateral values and things like that. And the other half of them are, generally speaking, in a bit of a runoff. And so I think the mix of those 2 things is kind of leading us to be relatively flat on an amortized cost basis. But I'd defer a little bit to Ted Gilpin on the specific accounting of that.

So yes, Steve, so obviously, CLO goes through the effective interest method for accounting, which will determine which pieces to take down of the cost, if you will, and which is recognized as income. And as those cash flows change quarterly, you'll get a different calculation as to what the pied IRRs and then what gets booked. And so typically, since they're either reinvestment, you would start to see the cost and the principal fees come down, but if those cash flow change significantly in a quarter, you may get a quarter where more of it is income and less of it is bring down the principal. But generally speaking, they should be -- continue to pay down over time, and so you'll see them diminish. So you're right, that's what you'd expect to see.

Okay. And the CLO income was down this quarter, even though the CLO mark went up. Was there something in the accounting that accounted for that?

Generally speaking...

As -- yes...

Go ahead.

If they're out of the reinvestment period, you have few -- less of cash coming in over time, right? You only have some in periods to bring forward. So the calculation would come out that you would tend to see some of the income come down as well.

Yes, there's a little bit of a timing lag between the accounting and the mark of the CLO equities.

So going forward, should the CLO income be more like this quarter or more like the last couple of quarters? Or do we not know at any given point in time?

Well, it's sort of -- it's one of the frustrating parts of CLOs, Steve, is that, that income is not necessarily predictable. But I would say that it would tend to be relatively similar to where it is at the moment, but although as they continue to pay down, I would expect that, that didn't come to lessen right away over time.

Okay. Yes. Yes. And I think importantly, obviously, the accounting will move things a little bit. But importantly, none of the CLOs -- a couple were shut off during the March period, but nothing -- there is no further degradation on the actual cash coming out of the CLOs. So that's at least a decent indication that it should be relatively consistent.

Okay. How about commenting on the mark -- the portfolio marks sort of subsequent to September 30, i.e., October, you had a mark when the -- so after September 30, you had a mark when the deal closed, you had a mark at the end of October. And obviously, you haven't marked it today, but sort of where do you think that has evolved, given the market's tightening?

I would say, I mean, from my perspective, I would say -- so pro forma for the merger, there's going to be some transaction costs that roll through NAV. Just legal fees and stuff to get it closed. So that's obviously a slight negative. But we -- as you've seen, like, there's been the continued tailwind in the credit markets. So hard to say, but when we set the -- you can back into our NAV as of the merger because you can look at how many shares were issued at the time, so you can actually look at that. And NAV is kind of like a little bit down, like flattish, but that's just transaction costs. And so again, it's a long-winded way of saying, I don't think there's going to be a material impact on NAV as we sit here today. So a little bit of tailwinds offset by some transaction costs.

Okay. And you started to talk about cost savings leverage in the acquisition, which obviously is one of the main goal of bigger BDCs buying smaller BDCs or combining them. When you look at the cost structure, what does your cost structure look like going forward versus what they had and what you had?

Yes. So I think, obviously, that is one of the big reasons to combine and get a little bit bigger. And so if you look at our income statement, you look at the expense side, professional fees, admin services and expense, insurance and other G&A, 1 plus 1 doesn't equal 2 in this case. So we would expect -- you only have 1 audit, not 2 anymore, right? Your expenses will increase a little bit as you have to have some more people working on some things, but I would expect that our expenses will become more in line with sort of the rest of the industry on a percentage of assets. And so we've been a little bit high. And now you put 2 companies of similar size together, and those expenses should only marginally go up. So I think that's where you're going to start to pick up.

Yes. I had heard that a lot of Garrison people had left Garrison before. So in big picture, how many people did you bring over? What did you -- did you have to bring over space? What are you going to have to do to your headcount, whether in your accounting area or otherwise?

Well, fortunately space is not relevant. Fortunately, space isn't too relevant during COVID.

Do you want to...

Well, that's not true. The rent expense portion of space may be relevant even if no one's using it?

Yes. That's true.

Yes. So those are good questions, Steve. We didn't -- we're not going to need to add more space. I mean, I think that we did bring over one person from Garrison as it relates to sort of the financial and accounting side. We'll have to have a little bit more allocation to the fund, obviously, because it's bigger and there's more positions and there's stuff to do. But again, it's not a big lift. I mean, we have lots of capacity.

Yes. I mean, I would answer it that versus what Garrison was spending, we're going to spend a lot less. That's very clear. So that all drops the bottom line. Within our own business, we've taken some cost actions over the last 6 months to take cost of our own business across professional fees, size of Board, things like that. And that all, again, just drops the bottom line. So we're not only focused on cost take-out side of the merger, we're also focused on our own business. And anything like any costs, like space and all that stuff again, like, we think the transaction on cost alone is about mid-single-digits accretive. And then if we can take their liquid portfolio and monetize it and recycle it into the types of things that we've been doing on origination franchise, we think that's pretty accretive. So we think the accretion can be even higher than that. So again, you've seen the spread pick up -- we've picked up in the last 9 months. Some of the spread widening in the markets, but a lot of that is monetizing some of these acquisitions, liquid assets and recycle them into more proprietary assets that have wider spreads. So between all those things, it should be mid- to high single-digits accretive.

Okay. I have one last question and/or comment, which I will repeat again, and Ted, you're probably expecting it.

Reverse split.

Have you given any further consideration to reverse merger now that your share count is bigger and you're done with this deal?

I think you meant a reverse split, stock split.

I'm sorry, reverse split, reverse split, yes.

Yes. Yes. I mean I -- sorry, to do that, we need a shareholder vote. And so...

I'm ready to vote.

Well, so -- and with management, it's something that we're focused on. And my guess is we'll do that in the next couple of quarters. I mean, it just makes sense for us to do it. And so don't be surprised to see us do a reverse merger -- or a reverse stock split over the next couple of months. I mean I think yourself and a lot of our big shareholders have suggested the same thing. And I mean, we think it's a good idea.

We have a follow-up question from the line of Christopher Nolan with Ladenburg Thalmann.

Ted, was that mid-single-digit accretive to EPS, I presume?

To NII per share. Yes.

Okay. Great. And then what are your thoughts in terms of lowering your funding costs, SBA debt or anything else like that?

Well, on the SBA debt, I mean, we are looking into it, but I would say -- and the terms on the SBA debt are very attractive. I'm not sure we can get an SBIC approved. And if we did, to get one approved, I think it would take us some period of time. So I wouldn't want to guide people to that. I think our bigger focus is on -- we have -- I mean, the great thing with our business now is we have a very diversified liability side between the CLO debt, our bonds and our bank debt. And during March, when some of our peers had issues around their bank lines, we're obviously very heavily skewed towards away from that now. And so I think between -- Ted mentioned it earlier, I think our focus is probably on tapping the unsecured markets at some point and at optimizing our CLO debt, just given all this cash we're taking in. So yes, we are very focused on reducing funding costs, but I don't think it's realistic for us to access the SBA anytime soon.

That concludes today's question-and-answer session. I'd like to turn the call back to management for closing remark.

Thank you all for joining us today. We really appreciate everybody dialing in for all the questions. And of course, myself, Patrick, Ted and the entire management team is always available to answer any questions or suggestions that you might have. Thank you very much for dialing in today. Thanks.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.