BlackRock TCP Capital Corp. (TCPC) Q2 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, good afternoon. Welcome, everyone, to the TCP Capital Corp. Second Quarter 2015 Earnings Conference Call. Today's conference call is being recorded for replay purposes. During the presentation, all participants will be in a listen-only mode. A question-and-answer session will follow the company's formal remarks. [Operator Instructions] And now I would like to turn the call over to Jessica Ekeberg, Vice President of the TCP Capital Corp Global Investor Relations team. Jessica, please proceed.

Thank you. Before we begin, I would like to note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance. Forward-looking statements involve risks and uncertainties, and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today and are subject to change without notice. During today's call, we will refer to a slide presentation, which you can access by visiting our website, www.tcpcapital.com. Click on the Investor Relations link and select Events and Presentations. Our earnings release and 10-Q are also available on our site. I will now turn the call over to Mr. Howard Levkowitz, Chairman and CEO of TCP Capital Corp. Howard Levkowitz Thanks, Jessica. We would like to thank everyone for participating in today's call. I'm here with our President and COO, Raj Vig; our Chief Financial Officer, Paul Davis; and other members of the TCPC team. This morning we issued our earnings release for the second quarter ended June 30, 2015. We also posted a supplemental earnings presentation to our website, which we will refer to throughout this call. We will begin our call with an overview of TCPC's performance and investment activities and then our CFO, Paul Davis, will provide more detail on our financial results. Next, I will provide some additional perspective on the market before we take your questions. I'll begin with a review of the highlights of our second quarter, which are summarized on slide four of our presentation. We had strong originations totaling $196 million during the quarter. We also had an unusually high level of repayments totaling $190 million. Our relatively flat net deployment underscores our focus on patiently seeking attractive investment opportunities versus over-emphasizing growth in the current environment. We delivered net investment income of $0.44 per share, which included both significant prepayment and syndication fee income. Our net asset value increased growing to $15.10 per share from $15.03 per share at the end of the first quarter. We declared a regular quarterly dividend of $0.36 per share payable on September 30, 2015, to shareholders of record on September 16. We received an investment grade rating from S&P, which we believe is a reflection of our disciplined investment strategy, the quality of our well-diversified portfolio, and our dedicated investment teams with deep and broad industry knowledge. And yesterday, we increased our TCPC funding facility to $350 million, up from $300 million, and expanded the accordion feature to $400 million. This credit facility has an attractive interest rate of LIBOR plus 2.25%. For those viewing our presentation, please turn to slide seven. At the end of the second quarter, our highly diversified portfolio had a fair value of over $1.2 billion invested in 87 companies across numerous industries. Our largest position represents 3.4% of the portfolio. In the second quarter, we continued to focus on investing in senior secured and floating rate debt. At quarter end, approximately 97% of the portfolio was in senior secured debt and 77% of these debt positions were floating rate. With most of our debt portfolio in floating rate instruments, we are well positioned for a rise in interest rates. During the second quarter, we continued to focus on allocating capital primarily to income-producing securities and deployed approximately $196 million in 18 different senior secured investments. These included investments in 7 new and 11 existing portfolio companies. Our investments in existing portfolio companies continue to be a source of strong risk adjusted returns for our shareholders given our pre-existing relationships with these firms and our knowledge of their business and operating model. Our five largest investments in Q2 reflect our diversification strategy and include a $41 million senior secured loan to Fidelis, a leading security software vendor; a $31 million senior secured loan to STG-Fairway First Advantage, a global provider of outsourcing and analytic solutions for the human resources and legal market; a $20 million senior secured loan to Arcadia Bio Sciences, an agricultural biotechnology trait company; a $17 million senior secured note to Caribbean Financial, a non-bank provider of consumer loans; and a $14 million senior secured loan to the Tennis Channel, a sports-oriented digital cable and content provider. In the second quarter, we exited $190 million of investments including a $37 million senior secured loan to STG-Fairway First Advantage, a $29 million senior secured loan to Acrisure, a $16 million senior secured loan to Palladium. As noted earlier, we also provided a new loan to STG-Fairway, which we have financed in a series of transactions since the initial acquisition in 2010. Our prepayments this quarter were unusually high and should not be annualized. New investments in the quarter had a weighted average affective yield of 10.7%, and the investments we exited during the quarter had a weighted average affective yield of 10.6%. This is the ninth consecutive quarter we have underwritten new investments at higher yields than our exits. Our overall effective portfolio yield for the quarter was 10.9%. A number of our investors have continued to ask us about our energy exposure, so I will provide a brief update on that now. First, I should remind you that we have a highly diversified portfolio and our direct energy investments included two loans, which taken together comprised only 2% of the fair value of our portfolio at the end of the second quarter. MD America received a large equity commitment from its owners and has stated that it plans to use the proceeds to repay our term loan in full. Our second direct energy investment is Jefferson Gulf Coast, which provides storage to oil producers. The company is benefitting from increased demand for storage solutions resulting from lower oil prices. Overall, we are pleased with the performance of our energy portfolio, and we continue to carefully evaluate opportunities in the sector. Now, I will turn the call over to Paul for a more detailed report of our second quarter financial results. After Paul's comments, I will provide some additional perspective on what we are seeing in the market then we will take your questions. Paul?

Thanks, Howard. We are pleased to report another strong quarter. Second quarter gross investment income was $0.80 per share or $38.9 million, which included recurring cash interest of $0.60 per share, syndication fee income of $0.02 per share, recurring tick income of $0.03 per share, discount and fee amortization of $0.09 per share of which $0.05 was from prepayments, and an additional $0.05 per share from prepayment premiums. As a reminder, it is our general policy to amortize upfront economics over time rather than recognize all of the income at the time we make the investment. Earnings for the quarter also included cash income from aircraft leases of $0.02 per share offset by depreciation expense of $0.01 per share reducing the Company's tax basis income. I show on slides 8 and 11 net investment income before preferred dividends and incentive compensation was $27.3 million or $0.56 per share, $0.55 per share after preferred dividends. Net investment income after preferred dividends and incentive compensation was $21.5 million or $0.44 per share out-earning our dividend by $0.08. Total operating expenses for the quarter were approximately $11.7 million or $0.24 per share, which included interest expense of $0.07 per share and non-recurring transaction-related expenses of $0.6 million or $0.01 per share. We also accrued dividends on the preferred leverage facility of $0.01 per share. Our annualized operating expense ratio including interest expense and preferred dividends but excluding the $0.01 of non-recurring transaction-related expenses was 5.9% of average net assets before incentive compensation. Incentive compensation from net investment income for the quarter was $5.4 million or $0.11 per share, which is computed by multiplying net investment income after preferred dividends by 20%. As noted in slide 12, all incentive compensation is subject to the Company meeting a cumulative total return hurdle of 8% annually. Net realized and unrealized losses were $2.2 million or about $0.045 per share comprised of net realized losses of $9.3 million and net unrealized gains of $7.1 million primarily due to the restructure of our loan to Edmentum in which we converted our investment into new debt and equity in a delevered company. TCP Capital Corp utilized our advisors' significant experience in restructuring during the process with our lender group assuming control of the company and the Board. Our entire portfolio is mark-to-market each quarter with substantially the entire portfolio priced using independent third-party sources with only a de minimis amount being priced internally. At the end of the second quarter, we had two loans on non-accrual. Our loan to Boomerang Tube and our second lien term loan to Core Entertainment. On a combined basis, these two loans represented less than 1% of the portfolio at fair value and impacted quarterly net investment income by less than $0.01 per share. Core Entertainment has been a disappointment and we are working hard to maximize the investment. After paying our second quarter dividend of $0.36 per share or $17.6 million, we closed the quarter with a tax basis, undistributed, ordinary income of approximately $27.2 million. Available liquidity at the end of the quarter totaled approximately $213.8 million, which was comprised of total available leverage of $180 million and cash and cash equivalents of $36.7 million less net pending settlements of $2.9 million. Available leverage includes the remaining $41 million available on our $75 million leverage commitment from the small business administration. Combined leverage net of cash was approximately 0.65 times common equity at quarter end. Subsequent to quarter end, we received exemptive relief from the SEC to allow us to exclude our SBA debt from the asset coverage requirements. We were also able during the quarter to repurchase $33.5 million of our preferred leverage at a price of $0.95 on the dollar generating a gain of $1.7 million. Turning to slide 13, at the end of the quarter, our total weighted average interest rate on amounts outstanding on our combined leverage program including both debt and preferred equity was 2.9%. This reflects our preferred equity facility at a rate of LIBOR plus 85 basis points, our TCPC funding facility at a rate of LIBOR plus 2.25, our partnership facility at a rate of LIBOR plus 2.5%, our convertible notes at 5.25, and our pooled SBA debentures at a rate of 2.85%. That rate excludes unpooled SBA loans, which are currently incurring interest at a temporary rate of 0.6%. I'll now turn the call back over to Howard.

Thanks, Paul. I will briefly cover what we are currently seeing in the market and then open the line for questions. In the third quarter to-date, our deal flow remains good, and we are seeing numerous opportunities across many sectors. We are continuing to see some aggressive pricing, including in connection with the repayments of some of our own loans this quarter, and continue to take a highly disciplined and selective approach to new investments and are passing on many opportunities. Through August 5, 2015, we have invested approximately $28.6 million primarily in six senior secured loans with a combined effective yield of approximately 9.8%. A number of these Q3 loans were the funding of existing commitments, and we are continuing to enhance our pipeline with additional commitments. We note that originations can be lumpy and neither the pace nor the yield should be annualized. Our primary focus remains on growing our recurring earnings stream by effectively putting our recently expanded and diversified liquidity sources to work to optimize our portfolio. TCPC has built a strong market position by leveraging our platform to lend to established middle-market companies with sustainable competitive advantages that generate significant cash flow and/or have significant asset coverage or enterprise value. In general, the middle-market remains healthy and continues to outpace overall growth in the US economy serving as a primary engine driving job creation. We believe demand for growth capital from the middle-market remains strong. Looking to the future, we are uniquely qualified for continued success for several reasons. First, we have scale and depth in our origination and servicing platform. We have a highly experienced team of more than 80 people firm-wide with our investment professionals organized into 19 discreet industry groups. We believe this structure provides us with a tremendous competitive advantage in sourcing transactions and gaining the trust of management teams, owners, and their advisors. Second, our focus on senior secured loans, most of which are floating rate, has resulted in a lower overall risk profile and strong portfolio performance. This has enabled us to consistently out-earn our dividend to grow our NAV, and to make special distributions on a number of occasions since we went public. In addition, our dividend coverage remains strong, and our portfolio is well positioned for an increase in interest rates. Third, our low cost of capital and diverse funding sources continue to be key competitive advantages for TCPC. In addition, TCPC remains well positioned with our attractively-priced leverage and financing flexibility which includes our convertible notes and our long-term, unsecured notes from the SBIC facility, which adds another source of low-cost funding. Finally, our interests are closely aligned with our shareholders. Our origination income recognition practices are conservative, and we have one of the most shareholder-friendly fee structures in the industry. We continue to invest alongside our shareholders and members of the management team and the Board of Directors have on a number of occasions including the second quarter purchased shares in the open market. In addition, as previously noted, our Board recently renewed a $50 million share repurchase plan in the event our shares trade below NAV. In closing, we are pleased with our performance in the second quarter of 2015. We are optimistic about our prospects for delivering continued growth and returns and based on our opportunity set and our growing origination platform. And we remain committed to our rigorous investment process that delivers high risk-adjusted returns while preserving capital over the long-term. We would like to thank all of our shareholders for your confidence and your continued support. And with that, Operator, please open the call for questions.

[Operator Instructions] Our first question comes from Chris Kotowski of Oppenheimer. Your line is open.

Good afternoon. I guess the first thing, we've seen a number of cases where there have been heavy pay downs and I guess it's somewhat surprising to me in that if you think back about the last year, in general the leveraged loan market has been trading a bit sloppy and leveraged loan yields seemed to have been going up even though -- not so much maybe in the new issue market but despite that we're getting a lot of pay downs. What accounts for that?

Hi, Chris. It's Raj. I'll try to address that. Yes, I think it's one of those things where a number of factors just converged whether it's coincidence or a fact -- a sense of the market that combined to drive a higher level of pay down than we've historically seen. When you look at the larger five or six repayments, they are a combination of refinancings and/or refinancings in connection with larger cap M&A. And when you think about where we fit in the market, we typically have companies that are -- they're not quite bank -- traditional bank loan or financing source ready, at least for the full capital stack, nor are they sort of capital markets ready. They're somewhere in between, but as these companies progress through their growth initiatives, they tend to graduate, if you will, to the next segment, and in this case the next segment for a number of these has been either the more broadly syndicated loan and/or bond market. And that just happened with a number of companies with larger position sizes that resulted in a larger level of pay down. I don't think, to Howard's point, that that should be taken as any sort of annualized or indication of the market. We still see good opportunities in the pipeline. We're actively working on a number of things where that capital can be redeployed in a reasonable time frame. But as you think back to even -- I think the one quarter, it was first quarter 2013, a similar event happened and by the way, we're comfortable with that because when you look at the prepayment fees that we got this quarter as well as the crystallization of the unamortized discount, the nice thing about the business model is it's okay to get repaid early. In fact, it results in good things often if you have the right structure. So, I think that this quarter hopefully is an exception from what we can tell. One of the things we're working on, it seems that can be the case. But every now and then in this business, because it is very lumpy, that can happen as it did this quarter.

Okay. And then Howard mentioned the new loans so far in the third quarter, a 9.8% yield, which is relatively lower than your existing portfolio and you noted how, in general, you had higher yields on -- entry yields than exit yields for the last couple of quarters. Is that just reflective of the environment or are those products--

Chris, appreciate the questions and the direction of them, which is it seems to be trying to get a better understanding, I think, of what's going on in the market and how it's impacting us. I wouldn't read too much into it. Although it's a six different credits and relatively small dollars in each, some of these are existing funding commitments that we have. In fact, that's the majority of them. And I wouldn't read too much into it. It's an average of some fairly small numbers given the size of our portfolio, and I don't think it's necessarily indicative of a broader change in the market. Now, the market is competitive. We are seeing some people, particularly some of the newer entrants doing some very aggressive things. We are passing on a huge number of deals as a result, but we still think there are a lot of interesting opportunities and we're signing up commitments for them and so I wouldn't say that five weeks, particularly over the summer, is indicative of a change in our portfolio mix.

Okay. Fair enough. And then last, there was a pretty big increase in legal and professional fees this quarter on the expense side, any color on that?

Yes. Mostly that was just points to $600,000 of one-time professional fees related to an expired shelf.

Okay. All right. That's it for me. Thank you.

Thank you for your questions.

Thank you. Our next question comes from Greg Mason of KBW. Your line is open.

Great. Thanks for taking my questions. First on the $0.02 of syndication fees, I don't recall hearing that before. Is that a new kind of opportunity for you guys or is this just first time breaking it out or have I just missed it before?

We haven't disclosed it before because it hasn't been as material as it was this quarter. There is no change in our business practice. That is, since 1999 we've been in the business of through our private vehicles previously and now also through TCPC of making loans, bringing in other parties sometimes on a pari-passu basis on the same basis and sometimes getting syndication fees in connection with those. Historically, TCPC hasn't had any that were that large. In this case, we had two situations in which we received significant syndication fees and it was material enough that we thought it was appropriate to provide a separate disclosure. It's a function of our platform that we see these opportunities. In both cases, they were companies that we had pre-existing relationships with that needed additional capital and we had loans out to them and we were able to bring in other parties and receive fees in connection with that.

Okay, great. Secondly, on the SBIC exemption, does this -- were you at all waiting for that before utilizing more of the SBIC facility? Do you think that will ramp up quicker or this is just a positive but hasn't really impacted your ramp previously and won't impact it going forward?

I'll take that, Greg. The answer to the various questions are no, it did not necessarily slow us down. I think we've seen the SBIC be a steady deployment. Obviously, the team in San Francisco focused on the venture community, has got some direct applicability with it. The expansion is a positive in our minds and gives us more capacity to deploy, but I think the -- we didn't necessarily -- because we have various funding sources and we assess which is the most applicable at the time of funding, it didn't necessarily slow us down, and I don't anticipate it doing that. In terms of going forward, like the rest of our business, the SBIC eligible transactions are a bit lumpy. I do expect that we'll continue to see some and deploy as appropriate. It's hard to predict how that deployment rolls out.

And just one other note on that, we had an early pay down in there. So there's more activity than you would see from that draws. When that happens, you get the cash back and recycle the cash before borrowing additional notes.

Great. Great color. One last question. I believe you brought on an energy team a bit ago. Are you seeing attractive opportunities in the energy space or is it still too early? Just your thoughts there given that you have relatively low exposure to energy right now in your portfolio?

Yes, so just to clarify, the team we brought on is really the venture [debt team and their focus originally and on an ongoing basis has been in what we broadly described as energy technology. And these are less opportunities [in the traditional energy fields versus something that's more disruptive where there's a very different type of structure and cash collateral investment typically alongside those opportunities. That being said, we have been -- we have a traditional energy team as well. That covers the broad value chain, and we have had that team and expertise going back to the very beginning of the firm. We are seeing a fair bit of opportunity and energy. We are by no means looking to rush into that because there's still a lot of volatility in the market and things that drive those investments that are a little bit hard to predict, as you can tell by the broader market volatility. But as we see things that have the right structure, protective structures, and sort of more asymmetric exposure with downside protection and some interesting upside, we'll assess those. The channel and the sourcing platform we have does bring those to the attention of the investment committee. So I expect that we'll continue to look and we'll try to find our -- pick our spots, but we are not going to change the overall risk profile and risk appetite of the business.

Great. Thank you, guys. Appreciate it.

Thank you for your questions.

Our next question comes from Robert Dodd of Raymond James. Your line is open.

Hi, guys. Just a few questions about the non-accruals. Obviously, I mean, you said Core Media - I'm sorry, Core Entertainment was a disappointment. Only the second lien is currently on non-accrual and there's the first lien as well. What do you think the -- difficult question, the probability is of that first lien having a problem, as well?

We are generally very happy to talk about individual companies. There is some sensitivity around this one, and so I don't think we can go into too much detail. We will stand by the statement that it's been a disappointment, and I would expect that on our next quarter call we'll be able to provide some more disclosure on it.

Okay. Perfect. I'll push my luck on Boomerang. You did a dip for that one. Does that mean that's moving faster and has a -- one way or the other, it's going to be resolved sooner or --

Yes, that one we expect to be resolved more quickly. Boomerang is a supplier, a low-cost supplier of pipes and equipment with it, primary market being the energy industry. So it's not a direct energy company. We talked about our two investments in that, but it certainly is impacted by it. It's one of the few companies we have that had that as a primary end market. And, so, fundamentally, we think it's a good, low-cost provider but as you can imagine and demand has come down quite dramatically. And so the company is in bankruptcy and there's certainly a contemplation that it'll be recapitalized and that that will happen before year-end, although that's not a certainty.

Okay, perfect. Thanks, Howard. Just one last one, I mean, you mentioned earlier in your comments or in response to one of the questions seeing some new entrants doing some aggressive things. Can you give us any more color on it, is that on the pricing side or the leverage that they're willing to offer to do deals and is that -- do you think that could have an increasingly distortive, relatively speaking, effect on the market and kind of setting expectations from what borrowers or peer groups are expecting to get if there's some aggressive terms being offered right now?

It's a great question. I don't know that we're willing to make the broad statement that you're suggesting. There are new entrants in the business, firms that didn't used to be in this, some of them associated with private equity firms, some of them free-standing entities, people who have decided that credit is a good place to be. Some of this has happened historically. We had a bunch of new entrants get into this business sort of between 2003 and 2007. Many of them exited in 2008, 2009, and 2010. And if you go back even farther, I think you see some of that also. You'd even see some of it with the banks, although clearly they're far more capital constrained. If you look at some of them in their direct lending activities in the middle-market, it's been very episodic, dedicating new teams and new capital at various times. And so in the nearly two decades that we've been doing this, we've seen people come and go. There are clearly some people today that are doing things both with respect to more aggressive terms and more aggressive pricing. Some of that may be simply different business models. Some of that may not be the kind of underwriting that we'd like to see. On the margin, it will have some impact, but I think if you look at what we were able to do in Q2, which was really a very significant number of investments in a large number of companies at attractive yields, we were able to avoid the impacts of that on our portfolio. And so we still think that it's a good environment generally for our business, but we are cautious, and we don't feel the need to put loans on the books just for the sake of doing so. Fortunately, we have a model that enables us to cover the dividend well at our existing size, and we're focused on finding good investments over the long run.

Okay. Perfect. Thank you. Really helpful color.

Thank you.

[Operator Instructions] Our next question comes from David Chiaverini with Cantor Fitzgerald. Your line is open.

Hey, guys. How's it going? Thanks for taking my questions. So, I also was hoping to get some more detail on Core Entertainment, but it sounds like that's too sensitive to talk about. But what peaked my interest was when you said it was particularly disappointing because clearly any loss or non-performer in an investment portfolio is disappointing but the fact that you pointed that out, it almost implies that there might have been something non-operational that was involved there, perhaps broader or something. But if you're not able to talk about it, we can move on to my second question -- and I'll put both questions out there and get your comments after, so, on your dividend policy, it's a pretty plain vanilla question, but so you're over-earning your dividend nicely, which is very good. I was just curious on your thoughts as to whether you're going to maintain that conservatism or at what point you would consider a dividend increase?

Sure. Thanks for the question. Since we've gone public, we've raised the dividend a couple of times. We've also done a number of special dividends. It's something that we continue to discuss with our Board on an ongoing basis. There are clearly different views on there. In the investor community, some people really like special dividends. Other people seem to think that it's better to accrete the value over time, and certainly holding on to the capital and the 4% excise tax is a pretty efficient way to grow in comparison with the comparisons or the alternatives rather. And so I think it's something we're going to continue to analyze at this point. Our biggest focus is on making sure that the existing dividend is well covered and comfortably covered and the advantage of out-earning it is simply that we get to keep that capital at an attractive cost and continue to grow our NAV.

Thanks very much.

Thank you.

Our next question comes from Christopher Nolan of MLV & Company. Your line is open.

Hi. Thanks for taking my questions. Howard, is there -- what's the outlook for continued repurchases of their preferred A?

Very limited. It was an unusual circumstance. We're pleased to have been able to do it. The opportunity was really created by a somewhat anomalous situation from a long-time capital provider who had some unique needs. I wouldn't anticipate any more of that going forward.

Great. And did you guys utilize the ATM this quarter?

We did. We issued about 235,000 shares this quarter.

And as I recall, your debt-to-equity ratio range is roughly 0.65 or 0.75 or so?

0.65 net of cash at the end of the quarter.

Okay, so it's -- your range is -- your DE range is typically 0.65 to 0.75, is that your comfort range?

I'm sorry, say that again.

What is the peak debt-to-equity range that you typically target? Is it still 0.65 to 0.75 or has that changed?

We've been fairly careful in trying to put an exact range on it. I think if you look at it historically it's rarely gone over 0.7 for any extended period of time, and given a larger portfolio, more diversified sources of funding in the SBA facility, we clearly have more flexibility in that regard, and it's something we continue to assess and look at. Some of it's also a function of market conditions and what we're seeing out there, but we haven't pointed out to an exact leverage target because some of it is really a function of things going on in the portfolio in the markets generally.

Yes, I would just add to that when you think about some of the deals that we work on and where we are able to extract some premium, if you will, a lot of it is based on flexibility in the business model to move quickly, fund quickly. Even an example of like buying the preferred back I think is -- it's important to have that buffer, so it's a balancing act, but we do think that there's a value to maintaining that buffer.

Great. Thank you for answering my questions.

Thank you.

Thank you. I'm showing no further questions. I would now like to turn the call back to Howard Levkowitz for closing remarks.

We appreciate your questions and our dialogue today. I'd like to thank our experienced, dedicated, and talented team of professionals at TCP Capital Corp. Thanks again for joining us. This concludes today's call.

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.