BlackRock TCP Capital Corp. (TCPC) Q1 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, good afternoon. Welcome everyone to BlackRock TCP Capital Corp’s First Quarter 2022 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 Katie McGlynn, Director of the BlackRock TCP Capital Corp. Investor Relations team. Katie, please proceed.

Thank you, Tomiya. Before we begin, I'll 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. Earlier today, we issued our earnings release for the first quarter ended March 31, 2022. We also posted a supplemental earnings presentation to our website at tcpcapital.com. To view the slide presentation, which we will refer to on today's call, please click on the Investor Relations link and select Events and Presentations. These documents should be reviewed in conjunction with the company's Form 10-Q which was filed with the SEC earlier today. I will now turn the call over to our Chairman and CEO, Raj Vig.

Thanks, Katie, and thank you all for joining us today for TCPC’s first quarter 2022 earnings call. I will begin today's call with a few comments on the market environment, as well as highlights from our first quarter results. I will then turn the call over to our President and Chief Operating Officer, Phil Tseng, who will provide an update on our portfolio and investment activity. Our CFO, Erik Cuellar will review our financial results, as well as our capital and liquidity positioning in greater detail. I will then conclude with a few closing remarks, before we take your questions. Turning to the current environment. Despite notable volatility in the public markets, direct lending continues to provide a reliable source of financing for a wide spectrum of middle market companies. We continue to work with a broad range of businesses, as they seek to finance growth, make acquisitions or simply refinance their existing debt with typically greater earnings power. As such, we believe that our shareholders continue to benefit from our efforts and expertise, as our investments deliver a premium source of predictable and mainly variable rate interest income at an attractive risk-reward level. I would note that the first quarter of the year tends to have a cyclically lower level of investment activity, as it did this quarter. However, our team reviewed a substantial number of opportunities and selectively deployed capital on favorable terms. As you all know, the last few years, since the initial onset of the COVID-19 pandemic, have been challenging on many levels. As I look back a little over two years from the depth of COVID, I'm exceedingly proud of the results we delivered for our shareholders in this challenging environment. Non-accruals throughout the pandemic have remained below 1% of the portfolio at fair value and below 1.8% of cost. We've also delivered a 28.5% ROE since the start of the pandemic, including net realized and unrealized gains on the portfolio over this period. These results are a testament to the hard work and dedication of our team, and I'm very appreciative of their significant effort. Let's now turn to a review of our first quarter performance and discuss a few highlights on the quarter. First, we delivered strong net investment income of $0.34 per share, which exceeded our first quarter dividend of $0.30 per share, resulting in a dividend coverage ratio of 113%. This extends our record of continuous dividend coverage throughout our 10 years as a public company. On May 4, our Board of Directors declared a second quarter 2022 dividend of $0.30 per share payable on June 30 to shareholders of record on June 16. Second, our portfolio credit quality remains very strong. As of March 31, non-accruals declined to just 0.3% of the portfolio at fair value with no new non-accruals for the quarter. Our excellent credit quality is a function of our disciplined and consistent underwriting, along with stable or improving profitability across many of our portfolio companies, both during the pandemic and in the post-pandemic period. Third, as Phil will discuss in more detail, the strength of our underwriting platform continues to drive significant investment opportunities that resulted in a total of $112 million deployed in 11 investments during the first quarter. This is driven by the strength of the relationships we developed with a broad variety of deal sources over are more than two decades in direct lending as well as the extensive resources and relationships of the broader BlackRock platform that we benefit from. I would note that although the direct lending market remains robust, middle market companies continue to opportunistically refinance their existing debt. This was the case in a number of our portfolio companies in the first quarter as we experienced $153 million of sales and repayments, resulting in net sales and repayments of $41 million. Fourth, Fitch reaffirmed our investment-grade rating with a stable outlook, and TCPC continues to be investment-grade rated by both Moody’s and Fitch. During the quarter, we continued to exceed our total return hurdle. As a reminder, TCPC maintains a 7% hurdle rate based on total returns, including a realized and unrealized gains and losses and with a cumulative look back. Since 2012, when we took TCPC public, we have generated a 10.8% annualized return on invested assets and a total annualized cash return of 9.7%. We believe that this is at the higher end of our peer group demonstrating our ability to consistently identify attractive opportunities at premium yields. We did see a slight decline in NAV of 0.6% during the first quarter, which was driven by wider credit spreads that resulted in minor net unrealized losses on our existing portfolio. These are partially offset by net investment income in excess of our dividend. I'd now like to spend a few minutes to provide the portfolio overview. At quarter end, our portfolio had a fair market value of approximately $1.8 billion. 88% of our investments were senior secured debt and are spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. Our portfolio continues to be weighted towards companies with established businesses, business models and less cyclical industries. At quarter end, the portfolio was made up of investments in 119 companies. And as the chart on the left side of slide 7 of the presentation illustrates, our recurring income is distributed broadly across our portfolio and is not reliant on income from any one company. In fact, nearly 90% of the portfolio companies each contribute less than 2% to our recurring income. 84% of our debt investments are first lien, providing significant downside protection and 95% of our debt investments are floating rate, positioning us well for the rising rate environment we are currently in. I will now turn it over to Phil to discuss our investment activity and portfolio positioning.

Thanks, Raj. Moving on to our investment activity. So while the number of direct lending managers has grown in recent years, we remain one of the small group of reputable lenders capable of providing complete and customized financing solutions. As such, we emphasize transactions where we act as a lead, co-lead or small part or part small club lenders negotiating deal terms and conditions that we believe provide downside protection on our investments. Also of note, our team is generally finding opportunities to invest in higher spreads than the average middle market transaction. This is a result of our extensive long-standing relationships developed over the past two decades, having delivered for borrowers and deal sources of over 1,000 transactions across the US private capital platform. In addition, our industry specialization, which our borrowers certainly value, enables us to assess and underwrite risk well. We sourced an increasingly large set of investment opportunities from multiple channels. And while we've been actively deploying capital in this market, we maintain a very disciplined approach to our investments. We regularly review the substantial number of opportunities in our pipeline, but we end up investing in only a small percentage of that. Market transaction models were needed at the start of the year relative to the record levels of activity in the fourth quarter of last year, but momentum picked up again towards the end of the first quarter. TCPC invested $112 million in the first quarter, primarily in 11 investments, including loans to eight new portfolio companies and three existing ones. Follow-on investments in existing holdings also continue to be an important source of opportunity for us, accounting for nearly 40% of our total investments over the past 12 months. Incumbency has become an important factor in sourcing opportunities, and we believe that advantage will continue for us. Certainly, from a risk management perspective, these are companies we already know and understand well, and therefore, are quite comfortable making these follow-on investors. As we analyze, the investment opportunities, we emphasize seniority in the capital structure, portfolio diversity and transactions where we can act as leader coli. Our largest new investment during the first quarter was our first lien delayed draw term loan to elevate brands, a consolidator of small to medium-sized brands that sell primarily through Amazon third-party platform. Our team identified the opportunity in consolidators of Amazon third-party sellers early on, leveraging our broader consumer and retail industry expertise. As a result, we have often been presented opportunities in this space early, allowing us to choose what we view are the highest quality companies in the space. Elevate specifically represented an opportunity to invest in the company with a strong management team and significant growth prospects with a loan structure that provides appropriate downside protection and upside through warrants. The second largest investment in the quarter was a first lien term loan to 4,840. The large provider recycled wood power solutions to the North American market. The company has demonstrated meaningful earnings growth through organic growth initiatives as well as acquisitions and is benefiting from several industry tailwinds, including the continued expansion of e-commerce. BlackRock Funds, including TCPC, provided the entire incremental term loan financing, which will support the company's near-term M&A plans. As Raj mentioned, new investments in the first quarter were offset by dispositions and repayments totaling $153 million as we had several successful exits and pay downs. These included the payoff of our loans to financial force Anne Klein, Kenneth Cole and Spark Networks. The overall effective yield on our debt portfolio was 9.1% as of March 31. Investments in new portfolio companies during the quarter had a weighted average effective yield of 8.4%. And the weighted average effective yield on exited positions was 9.2%. Given that 95% of our debt portfolio is floating rate and the majority of our outstanding liabilities are fixed rate, we believe we're well positioned as rates continues to rise. In fact, a further increase in base rates of approximately 60 basis points from the levels at March 31 would take substantially all of our floating rate loans above their floors and start to add meaningfully to our net investment income on those loans reset at the end of the quarter. We continue to invest selectively in maintaining our underwriting discipline, and being mindful of the inflation environment we're in. We focus on companies with established business models that are well positioned to succeed through cycles. And our pipeline today is healthy and we are sourcing opportunities across multiple sectors. The yields on investments in our pipeline are generally in line with our current portfolio. And to date, we have had limited prepayment income in the second quarter. Let me now turn it over to Erik to walk through our financial results, as well as our capital and liquidity positioning.

Thank you, Phil. Turning to our financial results for the first quarter. We generated net investment income of $0.34 per share, which exceeded our dividend of $0.30 per share. We're committed to paying a sustainable dividend that is fully covered by net investment income as we have done consistently every quarter over the last 10 years. Today, as Raj noted, we declared a second quarter dividend of $0.30 per share. Investment income for the first quarter was $0.73 per share. This included recurring cash interest of $0.60, recurring discount and fee amortization of $0.04, and PIK income of $0.04. Notably, our PIK income remains at its lowest level in more than three years. Investment income also included $0.03 of dividend income, and $0.04 from accelerated OID and exit fees. As a reminder, our income recognition follows our conservative policy, both generally amortizing upfront economics over the life of an investment, rather than recognizing all of it at the time the investment is made. Operating expenses for the first quarter were $0.32 per share and included interest and other debt expenses of $0.16 per share. Incentive fees in the quarter totaled of $4.2 million or $0.07 cents per share. Our net increase in net assets for the quarter was $1.4 million or $0.22 per share, which included net unrealized losses of $7.2 million, or $0.13 per share. Unrealized losses during the first quarter, primarily reflected mark-to-market adjustments across the portfolio as a result of wider market spreads during the period, as well as a $3.7 million reversal of previously recognized unrealized gains on our investment in CORE entertainment. These were partially offset by a $3.6 million increase in the value of our investment in 36th Street, a $3.4 million increase in Razor Group and a $2.2 million increase in their value of our investment in Hylan. Subsequent to quarter end, we fully exited our investment in core entertainment, the position we managed through several challenges. Ultimately, we successfully exited on investment following the company's acquisition by Sony [ph]. CORE is a great example of how we leverage our team special situation's expertise to help navigate challenged credits toward a favorable outcome. Substantially, all of our investments are valued every quarter using prices provided by independent third-party sources. These include quotation services and independent valuation services and our process is also subject to rigorous oversight, including back testing of every disposition against our validations. Our credit quality remains strong with non-accruals loans at quarter end limited to two portfolio companies that represent just 30 basis points of the portfolio at fair value and 90 basis points of cost. Now turning to our liquidity. We ended the quarter with total liquidity of $245 million relative to our total investments of $1.8 billion. This included available leverage of $201 million and cash of $44 million. Unfunded loan commitments to the portfolio companies at quarter end, equals 7.5% of total investments or approximately $134 million, of which only $29 million were revolver commitments. Our diverse and flexible leverage program includes two low-cost credit facilities, two unsecured note issuances, and an SBA program. As Raj mentioned, our unsecured debt continues to be investment-grade rated by both Moody's and Fitch. And in March, Fitch reaffirmed their investment-grade rating with a stable outlook. Additionally, given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing, and our maturities remain well laddered. Combined, the weighted average interest rate on our outstanding liabilities decreased to 2.91% from 3.26% at the end of 2021. Now I'll turn the call back over to Raj.

Thanks, Erik. To conclude, we delivered another strong quarter of results and are confident in our team's ability to generate attractive ongoing risk-adjusted returns for our shareholders in this complex environment. We have noted the increase in volatility in the public markets since the start of the year, driven in part by uncertainty around rates, inflation concerns and the war in Ukraine. In periods of increased volatility, we are reminded of the benefits of private credit and direct lending investments in particular, which have historically performed well throughout economic cycles. Our loans are typically at the top of the capital stack, often with collateral protection and with significant equity and/or subordinated capital structured below our investment. Additionally, we structure our loans with meaningful financial and maintenance covenants, and our portfolio remains well diversified by issuer and industry. In this environment, we are leveraging our team's competitive advantages, including 23 years of experience lending to middle market companies. Our long track record combined with our industry specialization makes us a unique and valuable partner to our borrowers and deal sponsors. In addition, our experience in structuring loans that are downside protected has helped to contribute to our exceptional long-term performance. With that, operator, please open the call for questions.

Absolutely. [Operator Instructions] Our first question is from Kevin Fultz with JMP Securities. Your line is open. Please proceed.

Hi. Good morning, and thank you for taking my questions. My first question relates to leverage. Right now, you're at net regulatory leverage of 1.02x, which is in the middle of your range over the past year. Considering the current environment, are you right where you want to be from a leverage standpoint, or would you be comfortable taking leverage up a bit from here given your conservative portfolio mix?

Yeah. Thank you, Kevin, for the question. I can kick it off and others can comment. I think first and foremost, we really are cognizant of maintaining the investment-grade rating in all environments, particularly as rates are going up. We think that's an important advantage for financing purposes. So where they sort of have their implied cap is something we're cognizant of, it may move around based on their perception of the space. But I do think that gives us a little more room to where we are today. Erik also mentioned some of the flexibility we'll look to maintain around undrawn commitments. And in the market, there really has become a part of being able to be competitively positioned to provide undrawn capacity has very much become the norm in the market we're operating in. So we're cognizant of maintain the rating and the leverage, but also that capacity to fund as those needs come up. I do think we have a little more room, and we're very judicious on where we're deploying the capital within that context, but hopefully that gives you a little more color around the question.

Okay. That makes sense. And then…

I think Erik will add something.

Yeah. I'm just going to add that we really don't manage to a target level of leverage because lack of flexibility. We'd like to look at deals one at a time. We're very comfortable looking or letting the portfolio shrink like we did this quarter, but we're not going to just deploy for the sake of deploying.

That makes sense, Erik. And then just one follow-up. Touching on prepayments, what visibility do you have around the cadence of prepayments?

Sorry, what visually do we have around the cadence of prepayments?

Yeah.

Very little. I think just look, if you look at the last two quarters, you saw very little in the last quarter and a pickup in this quarter. And I'd like to say we could average out over a long period and give you something that's more recurring. But the drivers of prepayments are just episodic. It can be opportunistic refinancing. A lot of it is M&A based and M&A by definition is hard to predict when it closes. So I do think we've done a nice job of getting the run rate of our NII back up to very healthy levels and the prepayment sort of dynamic just kind of flows through episodically as you saw this quarter versus last. So it isn't great visibility. But over time, it seems to be regular. It's just in any one quarter, it's hard to predict.

That definitely makes sense. And I'll leave it there, congratulations on the quarter.

Thank you

Thank you. Next question comes from Robert Dodd with Raymond James. Your line is open.

Hi, guys. Following up on that question on prepayment activity. And just the general theme is obviously the forward curve is moving higher, base rates are expected to go up, particularly today. And in the past, that has tended to produce some element of spread compression, that's certainly not going on in the broad markets right now with all the volatility. But if that does happen, would you expect an acceleration in those prepayments if spreads compress, or if spreads widen would you -- I mean, basically, as you said, a lot of it can be M&A rather than just opportunistically financing. But is there a particular driver where a market movement could accelerate or decelerate that?

Yes. Robert, I don't -- it's Raj. I don't necessarily think it's linearly correlated -- at least from our experience. I mean in a declining rate environment, obviously, to the extent it's opportunistic refi, there's more, I would say, of a logic of seeing it happen, which we did. In a rising rate environment, one, I don't know that spreads compress point-to-point, we're assessing that now, but it's also a higher volatility environment, which correlates against that. But if you think about, like I just mentioned, what the drivers are, at least from what we see, a lot of it is M&A. A lot of it is a business that, even in a rising rate environment may be able to evidence its ability to graduate, so to speak, to a more efficiently -- more liquid market. So, if the business model is evidencing itself to a more syndicated loan market or a bank or bond market, even in a rising rate environment, that can drive a repayment or prepayment. So, there's just many underlying factors that may not be rate-driven that make it episodic and drive it versus some linear correlation just the rate story from our perspective.

I appreciate that color. Thank you. Another one, if I can. On core entertainment, I mean, obviously, it's been an asset with you for a while now exited after quarter end. I mean on the books, it's marked pretty healthily above cost, about that $11 million premium fair value over cost. Does that fair value reflects roughly the actual exit? And obviously, that cost base is also a restructured cost basis. So, can you give us any -- I mean, what was the ultimate IRR from initial capital put in to exit despite the fact that obviously, you're recovering a lot more than the restructuring value is what appears to be.

Yes. Thanks Robert. This is Phil. So, I think you point out a good topic, which is a successful outcome on core after extensive time in dealing with the challenged credit and driving a favorable outcome for TCPC. The final outcome, we expect not to be too different from where the most recent 331 mark is. So, I think that directly addresses your question. The issue around the write-down that was coming, of course, from some later-stage negotiations, which -- that. But at the end of the day, we're quite happy and pleased with the outcome here. And to your point, the gain in the position--

Yes. And Robert, let me add, while we can't disclose the individual IRR, it was positive after a lot of work and a long hold as you rightly pointed out. So, I think it's another good example of maybe not as significant in dollars, but positive and a significant recovery in the hands-on work of really moving into an owner-operator type role, like mention some others that have come to exit. So, we're happy with the outcome and it was far where it was in the earlier day TCPC.

Thank you for that color Raj. Kind of with a positive IRR with a lot of work, I mean, that clearly points out that you -- a lot of work and sometimes appropriate and justified in terms of getting that capital return for the investors. So, appreciate the color and congratulations on both the quarter and the resolution of course.

Thank you.

Thank you. The next question comes from Christopher Nolan with Landenburg Thalmann. Please proceed.

Hi guys. On High/Low, I mean, it seems to be back on accruing status, extended maturities and all cash coupons. I mean, what happened there?

Yeah. We invest another credit that we worked very hard on, and we successfully restructured the company and right-size the balance sheet as a result of that. The remaining debt is performing again, and we feel that the company should be able to maintain that the coverage on the debt. Yeah. Just to be clear, you're looking at restructured securities now, so there is an ownership piece, including a board representation. We're sort of in the early days of just kind of segue from the core discussion. We're in the early days of this process with High/Low and have see the table, we did not exchange the entire stake into equity, and we try to keep balance and maintain a preference where we can. What remains is performing. And then, the balance that was exchanged is going to be reflected in the equity ownership on the books.

Great and a broader question, given that the firm has a background in restructuring and so forth, what do you guys see as a bigger systemic threat right now, the supply chain crunch or inflation?

I'll kick that off and ask others to comment. I think well, there's two a parts to that question. One is when do we see sort of an aggregate. And then, what do we see that's applicable to the portfolio because it is a little different. In aggregate, I think both are issues, clearly, issues of the day, we've got a lot of insight and feedback as the platform we're on, to assess really what's going on around the world, which is nice to have that access. As far as the portfolio goes, keep in mind, much of our portfolio is weighted towards services companies, software, professional services, financial services, we don't have a lot of true working supply chain exposure risk even though the supply chain exposure may be a risk in the market. We do see inflation, wage inflation and some good commodity prices, again, which aren't applicable to us being risk. But when we do our underwriting, we fundamentally want to understand that, these companies have pricing power. And we've seen that regular consistency that, whether there's wage inflation or other type of inflation in the cost of goods or operating expenses, the companies we've worked with, have a good ability to pass it on in terms of price increases or other forms of revenue benefit. So, I just wanted to parse the question from what's going on in the market versus what's going on in the portfolio.

Great. Thanks, Raj.

Thank you. We have a question from Ryan Lynch with KBW. Your line is open.

Hey. Good morning guys. First question I had, how much of the slowdown in activity that we saw in Q1, do you think is attributed just towards seasonality and kind of a really robust back half of 2021 versus sponsors, I guess, delay and uncertainty that they're looking at the rest of 2022 with inflation, labor issues, geopolitical, rising rates all those uncertainties out in the marketplace. Like what do you think was really the main contributor to the slowdown in Q1 because the latter of those issues, that's really not going to change anytime soon. So, I'm just curious of what – based on your answer to that question, what does the rest of the year look like? Do you see it from kind of sponsors, appetite to get back in the marketplace?

Yes. Thanks for the question, Ryan. So, our Q1 volumes, what we saw was March was substantially more active than January and February and April was more active than margin. I think May is becoming more active than April. So, I think what you're seeing is that certainly the beginning of the Q1, we think there's a lot of pull forward in volumes into 2021. And that was because of naturally uncertainty around rates, uncertainty around the market, the market started getting a little bit more volatile towards the end of the year, if I recall. And so, I think there's a tremendous pull forward in demand in Q4. So, we think that kind of going forward, based on the pipeline today and the level of activity, we think 2022 is actually going to be a pretty strong year. Now there's, of course, a lot of things we can predict within the markets and with events. But based on the activity levels that we're seeing month-to-month, it looks quite promising. At least our pipeline has been very healthy in the sectors that we focus on.

Okay. That's helpful color. The other question I had was, there's certainly been, I would say, an increased appetite and increased deal values surrounding certain direct lenders playing in the preferred space, particularly with some of these high multiple LDOs that are taking place? I know you guys usually talk about wanting to be high up in the capital structure. I just wanted to get your opinion on what do you guys – what's your guys take on some of the preferred equities that are getting done out there and you guys have an appetite to start playing in that market?

Yes, I'll take that. And I just want to add on to the just last question for Phil. Just a reminder that the sponsor activity isn't going to be the only thing that dictates our pipeline. We're very agnostic on deal source. So, there is actually a lot of non-sponsor activity that plays through, but the activity comment is consistent, just to a wider base of sourcing. In terms of the preferreds, I agree with you. I think there's been a lot of growth in sort of some of the junior [ph] capital out there to bridge the GAAP to deals getting done. We are biased to being senior near the top or at the top of the capital structure. We believe that our pipeline will continue to allow us to find the right type of deals for this business and strategy, which is focused on credit and also focused on stable well-covered dividend -- this quarter, evidence is I think we've always been open to reviewing kind of more of a risk on situation, just given the platform capability and the team's capability. But this fund and this business really is, I think, centered on a credit strategy where there is kind of premium return for safe -- relatively safe senior risk. And that may mean that we have ability to get warrants or some other kickers, which I think you've seen not the norm, but with some consistency, including in the recent quarters, I think preferred is probably a little bit further out of the mandate in my mind, doesn't mean that the firm or the platform can't participate or that we don't get those looks. We actually do quite regularly. I think we're finding very good opportunity in our pipeline for traditional middle market credit. That has allowed us to perform the way we performed through the pandemic in the most recent quarter. Q – Ryan Lynch: Okay. Understood. I appreciate the time today. A – Raj Vig: Thank you

Thank you. The next question is from Derek Hewett with Bank of America. Your line is open.

Hello, everyone and thanks for taking my questions. Most of my questions actually were already addressed. But maybe could you talk a little bit about your funding strategy once rates stabilize? Would you look to increase the level of unsecured funding, which dropped this quarter given that the converts mature, or are you comfortable with the existing level of secured funding? A – Erik Cuellar: Derek, this is Erik. I'll take that question. I'd say, yes, we definitely continue to mine the capital market. We like some flexibility. And certainly, the funding availability that we have currently gives us that flexibility. The markets, as you have seen, have been pretty rocky lately. So perhaps not the best time to go out to market. But certainly, we -- as you mentioned, it is lower than it's been the last couple of years. But if you remember, a couple of years back, this is around the percentage of unsecured debt that we had previously. So within a range, we'll look to go out to market if the conditions are right.

Thank you. A – Erik Cuellar: Sure.

Thank you. There are no questions waiting at this time. So I will now pass the conference back to Raj Vig.

Thank you. We appreciate your participation on today's call. I would like to again thank our team for all of their continued hard work and dedication through this period. I would also like to thank our shareholders and capital partners for your confidence and your continued support. Thank you for joining us. This concludes today's earnings call.

This concludes the conference call. Thank you for your participation. You may now disconnect your lines.