BlackRock TCP Capital Corp. (TCPC) Q4 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, good afternoon. Welcome everyone to the TCP Capital Corp Fourth Quarter 2016 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 Web site, 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.

Thanks, Jessica. We would like to thank everyone for participating in today's call. I'm here with our TCPC team. This morning we issued our earnings release for the fourth quarter and year ended December 31, 2016. We also posted a supplemental earnings presentation to our Web site, 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 details on our financial results. Next I will provide some additional perspective on the market before we take your questions. I will now review some of our key accomplishments for 2016. We invite you to turn to slide four of our presentation. First, our dividend continues to be an important part of our total return to shareholders, and in 2016 we paid dividends totaling $1.44 per share. Second, we continue to substantially out-earn our dividends as we have done each year since our inception. Third, we continue to raise equity and debt financing on attractive shareholder-friendly terms. We raised a total of $65 million in new equity investments through two new transactions. This includes $30 million in April through a private placement of convertible notes to CNO Financial which was converted to common equity in June, and an additional $35.3 million in early July though a registered direct offering of common stock at a premium to our net asset value. We incurred no placement, agent, or underwriting fees in either transition, which benefits both our existing and new shareholders. We are especially pleased that we've been able to efficiently raise growth capital during the volatile marketable environment that characterized the first part of the year. We closed a private placement of $140 million of convertible senior unsecured notes due March 2022 with an interest rate of four and five-eighths percent. Additionally, we obtained the second $75 million leverage commitment from the Small Business Administration, brining our total SBA commitment to $150 million. In June, S&P affirmed its investment grade rating reflecting our conservative leverage, focus on senior secured investments, and our broadly diversified investment portfolio. Our Board of Directors renewed our $50 million share repurchase plan at our most recent board meeting. Last, but certainly not least, we have outperformed both the S&P 500 total return and the Wells Fargo Business Development indices on a cumulative total return basis since our IPO, with a 79.8% total return based on market value, which is demonstrated on slide five. Now, on to the highlights of our fourth quarter, we had a record quarter of originations totaling over $207.4 million, and maintained approximately 81% of our portfolio in floating rate instruments. We had $179 million in dispositions for total net deployments of $28 million. Originations were generally weighted toward the end of the quarter, while our repayments generally occurred early in the quarter. Today, we declared a first quarter dividend of $0.36 per share. Slide six details our history of covering our dividend every quarter since our IPO. Turning to slide seven, our NAV increased to $14.91 from $14.84 during the quarter. Also on slide seven, you can see that our cumulative dividends plus NAV appreciation have generated a total return on our initial IPO NAV of almost 50%. For those viewing our presentation please turn to slide eight. At year end, our highly diversified portfolio had a fair value of $1.3 billion, and was invested in 90 companies across numerous industries. Our largest position represented only 3.5% of the portfolio, and our five largest positions were 14.1% of the portfolio. As you can see on slide nine, at quarter end senior secured debt comprised approximately 95% of the portfolio, with floating rate debt comprising 81% of our debt investments. As shown in the chart at the bottom of the page, with most of our debt portfolio in floating rate assets, we are well positioned for a rising rate environment. Turning to slide 10, during the fourth quarter we deployed $207 million primarily in 19 investments, most of which were senior secured in addition to draws under existing commitments. These included investments in 11 new companies, and eight existing portfolio companies. Our investments in existing portfolio companies continue to be a source of strong risk-adjusted returns for our shareholders, and reflect the strong relationships we maintain, and the value we deliver to our borrowers. Our five largest investments in the fourth quarter reflect our commitment to maintaining a diversified portfolio and our continued focus on the top of the capital structure. They include a $34 million senior secured loan to Envigo, formerly known as BPA Laboratories, a long-time borrower which is a contract research organization providing research services and essential products for pharmaceutical, crop protection, and chemical companies. A $32 million senior secured loan to AutoTrakk, a leading provider of auto leasing, a $24 million senior secured loan to Southern Theaters, the largest private movie theater chain in the United States, a $16 million senior secured loan to our long-time borrower Mesa, a regional airline, and a $15 million senior secured loan to Onyx CenterSource, the largest payments network in the hospitality industry. In the fourth quarter, investment exits totaled $179 million. These included the repayments of a $39 million senior secured note to BPA Laboratories, a $35 million senior secured note to Aquasure [ph], and a $29 million senior secured loan to BlackLine for which we continue to hold warrants. We are pleased with the overall quality and performance of our portfolio. New investments in the quarter had a weighted average effective yield of 9.8%, and the investments we exited during the quarter had a weighted average effective yield of 11.1%. Our overall effective portfolio yield at quarter end was 10.9%. Now, I will turn the call over to Paul for a report of our fourth quarter financial results. After Paul's comments I will provide additional perspective on what we are seeing in the market, and then we will take your questions. Paul?

Thanks, Howard. Starting on slide 12, the fourth quarter continued our record of covering our dividend every quarter since our IPO in 2012. Net investment income after incentive compensation before excise taxes and a one-time expense was $0.39 per share or $0.36 per share after excise taxes and the one-time expense, compared to our dividends of $0.36 per share. On a cumulative basis since the IPO we've out-earned our dividends by approximately $17.4 million. Net investment income for the quarter included $0.74 per share of interest income of which $0.59 per share was recurring cash interest, $0.02 was recurring PIK income, and $0.04 was recurring discount and fee amortization. The remaining $0.09 per share came from prepayment income including both prepayment fees and unamortized OID. Our income recognition follows our conservative policy of generally amortizing upfront economics over the life of the investment rather than recognizing all of it at the time the investment is made. Operating expenses of $0.29 per share included interest and other debt expenses of $0.14 per share for net investment income before taxes of $0.45 per share before incentive compensation. We also incurred $0.01 of excise taxes. Incentive compensation, which is subject to a cumulative 8% total return hurdle was $0.09 per share, which is computed by multiplying net investment income by 20%. Net realized and unrealized gains of $4.1 million or $0.08 per share came primarily from increased pricing due to tightening spreads as well as an unrealized gain of $4.6 million on our investment in Soasta in anticipation of the sale of the company, partially offset by a $3.4 million markdown on Iracore. Our net realized loss of $11.0 million during the quarter was primarily comprised of a $12.6 million realization on the restructuring of CORE Media in which we received significant equity. This was partially offset by gains of an additional $1.8 million on NEXTracker with the receipt of our first earn-out payment following the sale of the company in the prior year. Our credit quality remains strong. We took CORE Media off non-accrual during the quarter following its de-leveraging, and placed our Iracore notes in non-accrual. Our two non-accrual debt investments at quarter end represented 0.4% of the portfolio at fair value. Turning to slide 15, we closed the quarter with significant available liquidity. Our total liquidity of $421.2 million included available leverage of $380.0 million, and cash and cash equivalents of $53.6 million less net pending settlements of $12.3 million. Available leverage includes the remaining $89 million available on our $150 million leverage commitment from the SBA. Total leverage net of cash and SBIC debt at quarter end was approximately 0.60 times common equity. Given the premium at which our stock has been trading, we did not repurchase any shares under our repurchase program during the quarter. However, as Howard mentioned, our board nonetheless renewed the buyback program again this quarter, which provides for repurchases of up to $50 million should our stock decline below NAV. At the end of the quarter the combined weighted average interest rate on our outstanding debt was 3.9%. This reflects our TCPC funding facility, SVCP revolver, and term loan each at a rate of LIBOR plus 2.5%, our convertible notes at four-and-five-eighths and five-and-a-quarter, and our SBA debentures at a blended rate of 2.58%. I'll now turn the call back over to Howard.

Thanks, Paul. Now I will briefly cover what we are currently seeing in the market. As we have previously pointed out, post-credit prices changes have substantially reduced traditional borrowing source availability for middle market companies, causing borrowers to look to alternative lenders such as TCPC for lending solutions. As a result, we continue to see numerous origination opportunities across many sectors. At the same time, we are cognizant that there are many new competitors, some of whom are being aggressive. We continue to take a highly disciplined and selective approach to new investments. And while we are passing on many opportunities, we have a considerable number of attractive opportunities in our pipeline that meet our standards. In the first quarter through February 24, 2017, we have invested approximately $91 million primarily in five senior secured loans. The combined effective yield of these investments is approximately 10.2%. It is still only partway through the quarter, and our pipeline includes many transactions that are well within our historical yield range. Therefore the level and yield of originations to date are not necessarily indicative of what we may obtain for the quarter. 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. Our co-investment exemptive relief from the SEC, which was granted over 10 years ago, enables us to co-invest alongside the numerous private institutional funds we manage in order to provide comprehensive capital solutions to borrowers. Looking to the future, our primary focus remains on effectively deploying new liquidity from our diversified funding sources and optimizing our portfolio by preserving shareholder capital and maintaining a recurring earnings stream. We believe we are uniquely qualified for continued success for several reasons. First, our focus remains squarely on managing our portfolio to produce a consistent level of returns which enables us to maintain stability in our dividend. Our disciplined underwriting, which has helped us maintain strong credit quality, and to deliver consistent income and dividends to our shareholders. While we invest in many different industries and in companies we know and understand well, we continue to focus on companies that have sustainable competitive advantages and significant cash flow and/or asset coverage or enterprise value. Second, our focus on senior secured loans, most of which are floating rate, has reduced our overall risk profile and enhanced our strong portfolio performance. This has enabled us to cover a regular dividend every quarter. Our portfolio is well positioned for any meaningful increase in interest rates, and even a 25 basis point increase in rates would be accretive. Third, our low cost of capital and diverse funding sources continues to be a key competitive advantage for TCPC. The $65 million in new equity and the private placement of $140 million of convertible notes are examples of our commitment to accessing new innovative sources of capital in ways that are advantageous to our shareholders. TCPC remains well positioned with attractively priced leverage and financing flexibility that includes our convertible notes, a term loan, revolving credit facilities, and a long-term SBIC unsecured note. Fourth, we have outperformed both the S&P 500 total return and the Wells Fargo Business Development indices on a cumulative total return basis since our IPO nearly five years ago. 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 continued to purchase shares in the open market. In closing, we are pleased with our performance and achievements in 2016, and we are optimistic about our prospects for delivering continued growth and returns to our shareholders in 2017. We are well positioned to deliver another year of strong risk-adjusted returns with a strong capital position, a growing origination platform, and solid pipeline of opportunities that meet our rigorous investment process. 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.

Thank you, sir. [Operator Instructions] Our first question comes from the line of Robert Dodd of Raymond James. Your question, please.

Hi, guys. A couple of company-specific ones first, if I can. So as you said pending the sale, I mean has there been something definitive sign in terms of the sale there that's giving you confidence in the markup or is it just kind of an ongoing process?

Yes, we have something that gives us confidence in the process.

Okay, fair enough. On CORE Media, if I can, or [indiscernible] back when this first became [indiscernible] it seemed to, how best to put it, catch you a bit by surprise, and some of the things didn't seem to be going how you thought they should the type of investment it was. Has it resulted in any changes to either your underwriting or your documentation process for loans to kind of avoid something that you didn't seem too happy about at the time?

Yes, thanks for the question. As I think you know, we have a 20-year track record and experience of documenting and underwriting loans. At the same time there are always new things that you learn and things that come up that you haven't seen before. And so I think we try and learn from all of our investments, but particularly the ones that don't go well. And so I think, from this particular one, there are certainly a few things that we've thought about going forward that are going to be helpful to us in the future.

Okay, thanks. Last one for me. On the rate sensitivity, obviously you've got positive exposure. The question, I guess, would be how much of that do you think -- because obviously the disclosure in the presentation, et cetera, in the filings is static pool. How much do you think if rates do start moving higher, how much of it do you think is actually going to be -- you're going to be able to pass on versus given a very competitive environment, and I should say, some aggressive competitors out there. How much of that is going to be offset by just incremental competition pushing spreads down even further, and then kind of offsetting rate increases. Obviously there's core protection that -- how is that…

Sure. Let me bifurcate your question, which is with respect to every asset that we have we have a contract. And so to the extent that rates go up our earnings from those assets will go up according to those contracts and the spread-off of the indices, which are mostly LIBOR. With respect to new and future business, I think that remains to be seen. Our investments have always priced to a spread off of indices, generally LIBOR, regardless of where LIBOR has been. And clearly there are some people that are focused on absolute rates, at the same time many people in our industry also have leverage facilities. So their cost of borrowing will go up also. And so I think it's reasonable to assume that we will pick up most of that, although the competitive nature of the market I think is probably somewhat distinct from what's going on with interest rates.

Okay, got it. Thank you.

Thanks for the questions.

Thank you. Our next question comes from Ryan Lynch of KBW. Your line is open.

Hi, good afternoon. First question is on Mesa Air Group. You guys put out a press release a couple of weeks ago talking about $100 million of engine financing provided. So just two questions on that, first, what did you like about this investment, and why did you want to make that sizable commitment. And then number two, it looks like about $16 million that a $100 million showed up in the portfolio in the fourth quarter. And you also had two other delayed term draws also in the portfolio that were unfunded as of 12-31. So of that $100 million commitment that you made to Mesa, how much should we anticipate of that falling within TCPC versus other amounts spread across the Tennenbaum Capital Partners platform?

Sure. Thanks for the questions. With respect to Mesa, they've been a borrower for a long time. We have provided financing to them to help them grow. They're a very well run regional airline. We have been involved in financing aircraft and parts since 2003, and this is just part of that effort. We had an existing facility, and they look to expand it. We made the commitment across our platform utilizing both our private funds and TCPC. And amounts committed by TCPC to date are all reflected in the balance sheet.

Okay, got it. And then moving to your -- spillover income, in the past you guys have paid out a portion of your spillover income in the form of a special dividend. In 2015 and 2016 you didn't pay out any special dividends, and just chose to spillover that income and just pay the excise tax on those. As that spillover income grows and grows as you guys continue to overrun the dividend, which is a great job by you guys, but what are your guys' plans. Are you planning on continuing just to keep spilling this income over and paying that excise tax, or are you guys possibly considering any special dividends in the future?

Sure. Our Board continues to evaluate our dividend policy every quarter. As you pointed out in the past, we have done special dividends. We haven't done any recently. We continue to analyze this each quarter to think about what would be most optimal from the standpoint of our investors. There's a certain capital efficiency with respect to holding on to extra earnings, and keeping them inside as opposed to distributing them. But we're going to keep analyzing that going forward, and seek to do what we think is in the best interest of our shareholders over the long-term.

And then one last one, I get it's a difficult one, but you guys obviously have some very strong repayments in the fourth quarter. Is there anything you could point to that really drove the strong repayments in the quarter or is it just kind of over the normal course repayments or sometimes lumpy, and they happen to be lumpy and big in the fourth quarter. Was there anything you guys could really see? Was there any sort of push for companies to refinance or anything you can see in the fourth quarter?

So, I think you summarized it well. Our repayments or turnover was high; maybe double the rate at which it's been running over the last few quarters. Most of it is idiosyncratic. Ultimately repayments are simply a function of good underwriting. That's what we expect our borrowers to do. Sometimes they do it more quickly than we think or even than we'd like, but it's pretty normative, and it's not at all uncommon for it to be lumpy. I think the one really distinct nature was in Q4, and this was I think coincidental as opposed to any common reason, we had a lot more prepayments at the beginning of the quarter, and a lot more of our investments were made at the end of the quarter. So in general, we were running with a lower base of assets during a large chunk of the quarter.

Got it. Well, thank you for taking my questions. That's all for me.

Thanks for the questions.

Thank you. Our next question comes from Jonathan Bock of Wells Fargo Securities. Your question, please.

Hi guys, this is Jamie Sirockman filling in for Jonathan Bock. First, can you give a bit more color on the one-time expense; was this something BDC specific or platform-wide?

Yes, the one-time nonrecurring legal expense was just that. It was something that we had that happened during this quarter, and is something we don't expect to have in the future.

Sure, thanks. And one more on Green Biologics, seems the situation has improved there this quarter, but the loan appears to be accruing EOT. It's still marked under par. Can you walk us through the state of that investment?

Sure. The company is making progress. It had a delay in its construction, which isn't uncommon for investments of this nature, which was the reason for the mark. But we're encouraged by both the progress they're making in terms of completion, and also the incremental liquidity that's been provided by others involved.

Sure, thanks. And that's all for me.

Good. Thanks for the questions.

Thank you. Our next question comes from Christopher Nolan of FBR and Company. Your line is open.

Hi guys. Paul, the two non-accruals, what were they on a cost basis?

Yes, on a cost basis the non-accrual were about $15 million.

Great. And then, Howard, on a more strategic basis are you -- I'm sensitive to the point that you guys are very much senior secured loan focus, but for your portfolio companies are you seeing increased confidence out there whether looking for growth capital to actually equity, and they're looking to grow their businesses. I'm trying to get a temperature in terms of what peoples' capital planning outlook is for many of these lower middle-market, middle-market type companies, are they looking to grow?

Thank you. So are we, and so is the Federal Reserve, and I think a lot of others. I think we're hearing increased optimism in general, but I can't say that that has yet translated into significant concrete plans that we can identify that are anything other than idiosyncratic.

Great. Okay, thank you for taking my questions.

Thanks for the questions.

Thank you. Your next question comes from Christopher Testa of National Securities Corp. Your line is open.

Good afternoon. Thank you for taking my questions. Howard, just wondering obviously with spreads as tight as they are, and obviously your senior secured focus, is there any inclination or at least discussion in the company on possibly setting up the senior secured loan program?

We continue to look the various options for investing across TCPC. That's certainly something we've had discussions about over the years, and continue to think about. To date we have not set one up. We've been focused more on making the investments directly. But it's something we will continue to think about and analyze in the future.

Got it. And can you remind us what the private AUM is at TCP that you generally co-invest. And also if you're seeing potentially more deals towards the upper-middle market with larger borrowers, maybe there is less pricing pressure there due to capacity constraints on other lenders.

Sure. Our aggregate AUM is well over $7 billion. Some of that -- a significant portion of it is eligible for co-investment along with TCPC. Other parts of it invest in investments that are simply distinct and not appropriate for TCPC. I think we're clearly seeing a competitive environment which people have identified the larger borrowers typically have more access to more different sources of capital. On the truly larger side, certainly the syndication market and some lenders that are more focused on that. But there's also significant competition for some of the smaller companies as well. So I'm not prepared to generalize and say that at a certain size level we've noticed a true brink or distinction in competition.

Okay. That's great color. That's all for me. Thank you.

Good. Thanks for the questions.

Thank you. Your next comes from Merrill Ross of Wunderlich. Your line is open.

Thank you. With little description of having available liquidity well over $430 million, would you describe your balance sheet as being somewhat under-invested?

We don't have a targeted leverage level. We've made very clear over the years that although we certainly benefit from having leverage. And more of it enables us to increase earnings. We have sought to invest in assets that we think are good assets for us to make loans to, and are holding investments as opposed to having a targeted leverage ratio. We are really much more concerned with doing deals that we think are appropriate than trying to hit a target because of the incentives that that creates. And so we certainly have a fair amount of liquidity, we're pleased to have that. Some of that is in our SBIC, some of that is generally applicable to TCPC as a whole. We've always run though with a certain amount of leverage -- of liquidity.

Okay, thank you.

Thanks.

Thank you. Our next question comes from the line of Arren Cyganovich of D.A. Davidson. Your question, please.

Thanks. With respect to the SBA debentures that you have, you made a lot of investments in the quarter. I'm assuming that none of them must have fit that category to fulfill with that funding source. What's the outlook on the ability to find some investments to draw on that attractive financing rate?

Thanks for focusing on that. There's more going on in the SBA than you might see just from the aggregates, in that we've had a number of repayments. And so there's more activity and investment than our aggregate level would show. We've been probably a little bit surprised at how fast a few of these investments have come back. Ultimately, as the lender -- that's not a bad thing, we're in the business of getting our loans repaid, and sometimes it happens more quickly. We've been a little surprised by the velocity of these. I think it's more coincidental than anything else. We continue to look for eligible investments. To be very clear though, we view the SBA as one of the tools in our toolkit, a terrific one. We appreciate the partnership with them. And it's great to be able to utilize it, but we only do those deals that are appropriate, and when they are financed. And as I think you're probably aware, there are a lot of specific rules on eligibility. And so sometimes something may on size but have some other features that make it ineligible. So it's our hope and expectation to be able to continue to deploy more of it in the future certainly, but without any timetable.

Makes sense, thanks. And then the -- I'm sorry, did I miss the year-to-date investment total that you mentioned earlier in the call?

You talking about the year-to-date acquisitions?

Originations.

Through February 24, $91 million.

Okay. And I have -- I also apologize, did you mention the dollar amount and per-share amount of spillover taxable income you have currently?

Yes, at year-end we had taxable spillover income of $11 million, that's tax basis as we noted, we've earned over $17 million in excess of our dividends, and that's on top of the amount we had at the time of the IPO. The book tax difference just relates to some net investment income we classify as capital gains, and has a very distinct advantage for us in that we have a specific asset in the capital loss carry-forward that allows us significantly reduce our excise tax bill, and also allows that difference to effectively be retained or distributed to shareholders tax-free.

Okay, so the effective amount of spillover income is higher than the $11 million you have in the 10-K.

Right, our spillover income is $34 million, on a tax basis it's different just to take advantage of the significant asset we have in capital loss carry-forward.

Got it. Okay, thank you.

Thank you. At this time I'd like to turn the call back over to CEO, Mr. Levkowitz, for any closing remarks. Sir?

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

Thank you, sir, and thank you ladies and gentlemen. You may disconnect your lines at this time. Have a wonderful day.