Crescent Capital BDC, Inc. (CCAP) Q4 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the THL Credit Inc. Earnings Conference Call Fourth Fiscal Quarter and Year Ended December 31, 2019. It is my pleasure to turn the call over to Ms. Lauren Vieira, Director of Investor Relations of THL Credit Inc. Ms. Vieira, you may begin.

Thank you, operator. Good morning, and thank you for joining us. With me today are Chris Flynn, our Chief Executive Officer; Jim Fellows, our Chief Investment Officer; and Terry Olson, our Chief Operating and Chief Financial Officer. Before we begin, please note the statements made on this call may constitute forward-looking statements within the meaning of the Securities Act of 1933 as amended. Such statements reflect various assumptions by THL Credit concerning anticipated results that are not guarantees of future performance and are subject to known and unknown uncertainties and other factors that could cause actual results to differ materially from such statements. The uncertainties and other factors are in some ways beyond management's control and include the factors included in the section entitled Risk Factors in our most recent annual report on Form 10-K as updated by our quarterly report on Form 10-Q and our periodic and other filings with the Securities and Exchange Commission. Although we believe that the assumptions on which any forward-looking statements are based on are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. You should not place undue reliance on these forward-looking statements. THL Credit undertakes no duty to update any forward-looking statements made herein. All forward-looking statements speak only as of the date of this call. Our earnings announcement and 10-K were released yesterday afternoon, copies of which can be found on our website along with the Q4 earnings presentation that we may refer to during this call. A webcast replay of this call will be available until March 16, 2020, starting approximately two hours after we conclude this morning. To access the replay, please visit our website at www.thlcreditbdc.com. With that, I'll turn the call over to Chris.

Thanks, Lauren, and good morning, everyone. Before we jump into the earnings recap portion of the call, I want to briefly talk about the First Eagle Investment Management and why we’re excited about this transaction. First Eagle Investment Management acquired THL Credit Advisors, the investment advisor to TCRD on January 31. For folks who don’t know First Eagle is a large investment firm with approximately $100 billion of assets under management and has a long history dating back to 1864. The firm is privately held and its investment capabilities include equity, fixed income, private credit and multi asset strategies. The firm is best probably known for its global value fund. First Eagle Alternative Credit, the name under which the combination of First Eagle’s existing private credit platform and THL Credit Advisors now operates, has $23 billion of assets under management, including $7 billion in direct lending. The same THL team is continuing to run the business under First Eagle, while ownership has changed, our strategy as it relates to direct lending and the BDC remains the same. We are looking to run a highly diversified portfolio first lien loans and sponsored-backed companies with $5 million to $25 million in EBITDA. Our MAX investment holds size across the direct lending platform has increased, which we believe improves our competitive positioning in the market. To be successful at managing our public BDC, you need access to directly originated well-structured credit and a balance sheet large enough to execute your originated efforts, which allows you to underwrite quality transactions while maintaining prudent diversification. You also need access to capital to scale the business. We believe our clients, including our BDC shareholders, benefit from the increased size, scope, relationship, network and investment capabilities of the combined direct lending platform. The broader First Eagle platform brings significant resources to access to a variety of investor channels as well as capital for M&A and new products, all of which will be good for the BDC. Now I'd like to start by providing an update with respect to the BDC's ongoing strategic plan. The key component of the plan, which we communicated two years ago, were to run a highly diversified -- a highly diversified, first lien floating rate BDC with reduced concentration positions, specifically anything greater than 2.5% of the balance sheet and reduce our non income earning equities. Since 2017, we've executed on the strategy. We reduced non-income equity positions from 7% of the portfolio to 2% of the portfolio. We reduced our concentrated names from 14 down to 4, and we've added 22 new direct lending investments to the portfolio with an average old size of less than $10 million. Lastly, we've increased our first lien exposure, including Logan from 77% to 90%. The legacy portfolio pre-dating 2015 is now isolated to 6 names, compared to 17 at the end of 2017. It's important to note that the stress in the portfolio has been and remains concentrated on this legacy book. In fact, of the net realized losses we've taken in 2018 to 2019, 100% of them were correlated to the vintages of 2010 to '14, as illustrated on Slide 17 of our updated investor presentation. As we’ve communicated this first lien centric, diversified portfolio strategy, we saw permission during our last annual meeting to permit additional leverage on our BDC, a proposal that received clear support from our shareholders. We only intend to utilize this leverage when the quality of our equity base is stable. Then we will seek the necessary approval from our senior lending group to increase leverage. As a public shareholder, I'm sure the question at hand is, "so what?" You've made significant progress, but the stock still trades down at a discount like many other BDCs. While we've had a few positive efforts from the legacy portfolio Copperweld and Tri Starr, we've also had challenges as it relates to both exits and our inability to exit certain positions with Charming Charlie, OEM and Holland. Nonetheless, we're very close to closing this chapter and moving forward. We exited Martex, our last subordinated debt investment at a discount, but it still generated at a positive IRR on the investment. We also exited Virtus, one of our concentrated positions at par in Q4. Holland was added to the nonaccrual this quarter is now marked at a level where we expect to realize proceeds in the coming months. OEM, which has been marked down this quarter, remains challenged, but is in formal processes to be sold or merged in the coming months. While I believe the company has made significant strides in the enhancement of its proprietary technology, there still exist execution risk on the business plan. We -- the company and its advisors are actively managing several options to exit this position. 90% of the NAV decline this quarter was related to these names: Martex, Holland and OEM. The names that we highlight on our last several earnings calls and the net investment income, miss relative to the dividend was primarily a result of Holland going on non-accrual and Martex not accruing income in Q4 ahead of the exit business from -- ahead of the exit from the portfolio in December. If you look at what's the most valuable in fixed income today, it's true directly originated loans that are high yielding and well structured. In the last two years, we've added 22 of those investments. However, the solid execution has been overshadowed by our legacy portfolio workouts. Next, as noted in our release and 10-K filed yesterday, with the support of First Eagle and the former owners of THL Credit Advisors, we've committed to buy $30 million worth of newly issued shares of TCRD at NAV. TCRD will use these proceeds to tender shares in the same dollar amount if and when shareholders approve the management contract. We believe this is the most effective way to show our support for the shareholders by taking action that we expect will be immediately accretive. This also enables TCRD to buyback public shares without continuing to shrink its balance sheet. As also noted in the earnings release, First Eagle has agreed to waive 100% of the management fee and incentive fees for Q3 and Q4 in connection with the approval of the investment manager contract as we continue to work towards exiting these legacy investments. The management fee waiver is being provided to act as a buffer to dividend coverage as we look to finalize these efforts. Moving on to the fourth quarter, we aggressively move to exit our remaining legacy credits. The actions resulted in a significant markdown of select credits, as I mentioned earlier, that will put interim pressure on the dividend as we look to finalize converting these positions to cash that we intend to reinvest in the yielding credit. However, we see the light at the end of the tunnel. We expect to be out of most of our concentrated legacy credits this year and will allow -- which will allow us to pursue increased leverage, seek to grow the portfolio and focus on running the highly diversified first lien floating rate BDC. With that, I'll turn the call over to Terry to discuss our Q4 results in more detail.

Thanks, Chris, and good morning, everyone. First, some portfolio highlights. As of December 31, our $384 million portfolio was invested 69% in first lien senior secured debt and 21% in the Logan JV. As a reminder, the Logan JV is 98% invested in first lien assets. The remaining 10% of TCRD's portfolio was held in second lien and other income producing equities that you can refer to Slides 12 and 13 in our earnings presentation, which highlights these trends over the last two years. The weighted average yield on the debt and income producing portfolio, including Logan, was 8.7%. The decline over the quarter is primarily due to adding a new non-accrual and the exits from two of our higher yielding assets that were placed -- were replaced with lower yielding assets this quarter. Total on accruals as a percentage of TCRD's portfolio at fair value and cost increased to 8.1% and 3.9%, respectively, with the addition of Holland in Q4. Loadmaster remains the only other company on nonaccrual at the end of the year. Moving on to the financials for the fourth quarter. The NAV declined by 8.4% to $7.64 per share, largely due to the write downs Chris mentioned and the loss taken on the sale of our position in Martex outside of OEM and Holland or maybe the portfolio continues to perform well. NII for the quarter was $0.16 relative to the dividend of $0.21. Our spillover income, which was approximately $0.25 as of December 31, covered the difference. Looking at some components of our $10.1 million of investment income this quarter, interest income decreased this quarter primarily due to the Holland and Martex nonaccrual and then dividend income also decreased due to the realization of Copperweld in late Q3. On the expense side, total expenses for the quarter were $5.2 million compared to $5.8 million in Q3. The decrease was primarily due to lower interest and fees on borrowings. Net realized loss of $5.8 million in Q4 was primarily related to the sale of our position in Martex. About half of this loss was reflected in our NAV at September 30. From a leverage and liquidity perspective, leverage levels were within our targeted range as of December 31 at around 0.7x. During the quarter, we invested $24 million in a portfolio of 8 broadly syndicated loans on a short-term basis to manage excess liquidity from the repayment of Virtus, which was one of our more concentrated positions Chris mentioned. We sold out of all of these positions last week at a modest gain and the proceeds will be used to fund additional direct lending investments and paid on our revolver. Leverage currently sits around 0.75x. Our plan is to take leverage up modestly in the back half of the year once we exit the remaining legacy assets, subject to amending the credit facility. We will continue to evaluate our debt stack from a size and structure standpoint as we reposition the portfolio and take on increased leverage. As a reminder, our longer term leverage target is 1.1x to 1.2x. We continue to execute on our buyback -- share buybacks in Q4 completing the $15 million 10b5-1 program put in place last March and started a new program at December. To date, we’ve purchased $2 million under this new plan. With that, I'll turn the call over to the operator for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Robert Dodd with Raymond James. Your line is open. Please go ahead.

Hi, guys. I mean, you mentioned, obviously in the prepared remarks, interim pressure on the dividend. I mean, can you give us -- obviously, with the NAV taken a dip this quarter to maintain an $0.84 dividend on a $7.60 NAV requires a double-digit ROE. With your new strategy of -- not really new, but the transition to more secure assets and do you continue to believe that that $0.84 is sustainable in terms of coverage from NII once the rotation is complete?

Hey, Robert. It's Chris Flynn. I appreciate the question. I think it's a fair question. Obviously, with any type of volatility, not only relating to investors being on non-accrual, but also the potential of taking a loss would put pressure or could put pressure on that dividend. What we're trying to do and assess is clean the portfolio. Get stable equity base. We can drive there -- we can drive the leverage higher, which would enable us to push for a higher ROE. We're not in a position right now to provide guidance on 2020 future earnings until we exit these last two investments, though.

Okay. Got it. I appreciate that. And then on the -- can you give us any color on timing of the vote for the approval of the new management contract? And then also with -- and obviously this is more of a question for the Board, whether there's been any other parties that have firm-hatched into the name, so to speak?

Robert, this was Terry. Appreciate the question. We intend to file a preliminary proxy in the near-term. We anticipate that the record date for any shareholder meeting to approve the new investment management agreement will occur after April 21, which is the date we've indicated that the shares will be acquired. That's all I can say on this at this point on that.

Got it. And then to your knowledge, has anybody else approached the Board with an alternative offer? Or this -- the proposal from the adviser, as it stands, the only one on the table?

No, Robert.

Okay. I appreciate it. Then one more, if I can. On OEM, obviously, I mean, yes, it's a concentrated position. It's been a little while. It's really the first time that I can remember where it's taken a discount mark, though, I think it's been marked at par for most of it, for at least the last couple of years that I can remember. So can you give us any color on what shifted there in -- stress wise and confidence level in the market as it stands today? Thanks

Yes. Thanks. You're right on the debt position. There has been much movement. We have over time, written down what would have been our equity position. So there has been some movement on NAV associated with the name. Today as we sit back, we're taking in the combination of what we think the business is willing to or able to produce from a cash flow basis. And determining the valuation we're also taking into consideration various indications we've had from discussions regarding the M&A process that we're in the middle of it as we speak.

Got it. I appreciate it. Thank you.

Thanks, Robert.

Thank you. And our next question comes from the line of Ryan Lynch with KBW. Your line is open. Please go ahead.

Hey, guys. Just wanted to have a follow-up question regarding the discussion on the dividend. I guess, I'm just trying to understand the thought process. I know you said you guys are trying to work through a couple of things. So you guys didn't want to change the dividend around as you guys are working through a couple of your issues. But with an 11% dividend yield on book value, I mean, that's just, in my opinion, not anywhere close to sustainable, given your guy's risk profile that you guys are trying to target with a new BDC. So until you guys make a correction with that, you guys, you're just going to continue to return capital and pay out book value as part of that dividend. So I just -- I'm not understanding the thought process to why not take action sooner when in my opinion that dividend clearly needs to be reduced.

No. Thanks, Ryan. It's a fair question. I think from our position, there's two things. One, if there is going to be a move on the dividend, we want to do it once. So we want to do it with the most accurate information that we have. And second, in an attempt to potentially buffer some of that potential volatility, given the transition that was part of the decision process that was driving our election to waive the management fees for Q3 and Q4.

Okay. And then I know you kind of tweaked the leverage target just a little bit. Can you maybe go over -- you mentioned a little bit about stabilizing the equity base. Can you just maybe provide a little more detail of what you need to see in your portfolio? I don’t know if it's credit statistic, I don’t know if it's NAV stabilization, I don’t know if it's portfolio rotation. Can you just go over kind of the metric that you guys are looking at, seen in your portfolio, in your company before you guys kind of actually look at implementing that higher leverage target?

Hey, Ryan. This is Terry. Thanks for the question. I think -- to cut through the chase, it's really the exit from a substantial portion of these legacy investments, right, which have the most now volatility, which is what we want to eliminate before we start to take leverage up beyond where we've historically carried it. We've told that to this group several times before we discuss that with our lending group. And we're not going to do something that doesn't make any sense, ahead of that. So when we talk about -- in my remarks, I view it as, look, we think we can exit some of this stuff in the near -- clearly, the next couple of quarters, which will allow us to take leverage up from the 0.75x up towards 1 to 1 by the end of the year, assuming things proceed accordingly. And we're able to obviously amend our credit facility, which we did anticipate being able to do without this now volatility in the portfolio. And I think if you think about the target, that's a little longer term, more into 2021. So I hope, you're not going to see us doing this until these names are gone. And if you do, then I think you could poke at us. But I think we're going to be responsible on how we've done it and how we've managed the portfolio over time here.

And then maybe this one is for you, Chris. I mean, if I take just a kind of a higher level view of TCRD over the last several years, clearly, outside of the BDC, THL Credit had been raising. I know a decent amount of direct lending funds across your platform and now manning -- working with First Eagle, you guys have -- I think pretty significant direct lending platform, which keeps you guys relevant in a space and all that. But if we focus on TCRD for a minute, I mean the -- your guys' equity base at the BDC has dropped significantly, basically been cut in half the last several years. The discount to book value, you guys are now trading at 160 million market cap today. You guys continue to buy back shares, which is the right thing to do, but it keeps basically shrinking. TCRD from just the BDC standpoint, from what investors are looking to invest in. Are you worried about this entity, just the BDC, of course, you guys have a larger platform, but the BDC just kind of continuing to shrink and fall less and less relevant from a BDC investor standpoint.

Thanks, Ryan. I appreciate the question. Obviously, we've been disappointed with the results in TCRD, especially given that to your point the success we’ve had in raising capital, privately, the platform itself is growing back in 2014, I think we had roughly $3 billion to $3.5 billion under management and TCRD stand alone may be able to grow up to 17. So while these losses of this underperformance, unfortunately, has been somewhat concentrated in this public vehicle. So for that obviously, like I said, we're disappointed. With that said, as we look about -- think about the combination with First Eagle, it's much easier for us to, carry a BDC this size. I do believe once it gets stabilized, once we’ve finished exiting the two credits, we actually think we can turn this thing around and actually grow it. First Eagle brings a lot of incremental capital, potential balance sheet and additional resources for future M&A. So it's something that was important through the diligence process on us. They recognized that the vehicle itself had underperformed, but they looked to it as a very good option for growth in the future once these last few investments are exited. We are trying to show that support, obviously with the $30 million investment in the management fee waivers. They’re going to be supportive of the vehicle just as THL was historically.

Okay. Understood. Those are all my questions. I appreciate the time today.

Thanks, Ryan.

Thank you. I'm showing no further questions. I would like to turn the conference back over to Mr. Chris Flynn for any further remarks.

I appreciate all taking time today to join the call for our fourth quarter earnings update. I hope we provided a helpful update on the BDC as we evolved over the last few years, and it's setting in as we exit these legacy assets. With the full support of First Eagle, we believe, TCRD is well positioned for success and we will continue to support our shareholders. We look forward to providing everyone an update next in Mat. Thank you.

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