BlackRock TCP Capital Corp. (TCPC) Q2 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, good afternoon. Welcome everyone to BlackRock TCP Capital Corp’s Second 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, Bethany. 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. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, we make no representation of warranty with respect to such information. Earlier today, we issued our earnings release for the second quarter ended June 30, 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 second quarter 2022 earnings call. As usual, I will begin today's call with a few comments on the market environment, as well as highlights from our second 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 then 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. As many of you are aware, the current economic environment is characterized by negative GDP growth, the highest inflation rate in generation and aggressive Fed tightening. Within this environment, direct lending continues to be a reliable source of financing for a wide spectrum of middle market companies and a reliable source of returns for investors. We have often noted that direct lending has outperformed other segments of the market during periods of instability, and we believe that remains the case in the current environment. As a reminder, the assets we invest in are typically senior in the capital structure and underwritten with meaningful lender protections. These often include significant collateral packages and contain real covenants, specifically tailored to each borrower's business and industry. Our strategy has always focused on core middle market businesses in diverse, resilient and less cyclical industries. These companies have historically outperformed their larger corporate counterparts during economic downturns. For example, during 2007 to 2009, the middle market added 2.2 million jobs while larger businesses actually shed 3.7 million jobs. It seems like we have been living in "unprecedented times for some time now". Prior to 2020, none of us have considered a global pandemic and an economic shutdown in our base case underwriting. Since the initial COVID shock pandemic and supply chain pressures have contributed to an inflationary environment that many haven't experienced in quite some time or ever for that matter. However, our team's proven ability to identify and invest in businesses that successfully managed periods of economic stress, gives us confidence in the resiliency of our approach to direct lending. Regardless of the market environment, we have always been disciplined on our underwriting standards and evaluated the borrower's ability to manage in time address through both a forward-looking view and historical lens of performance through prior periods of stress. We remain confident in the strength of our diverse portfolio to continue to withstand periods of economic volatility. So what does this all mean for the existing portfolio? I'm very glad to report that the portfolio remains in excellent shape. Clearly, in many sectors, growth is slowing, inflationary pressures, especially for wages has resulted in a degree of margin erosion and where applicable, supply chain issues have further pressured earnings. However, we have been pleased with our borrowers of proactive actions to these pressures, including curbing spending and their ability to find cost savings in other parts of the organizations. We have also been able to further validate relatively inelastic demand for their products or services and have observed an ability to pass along cost increases to their end customers. Furthermore, given the floating rate nature of our strategy, interest rate increases are actually a benefit to our portfolio. And of course, we continue to closely monitor our borrowers' ability to service debt in a rising rate environment. Let's now turn to our second quarter performance and a few highlights from the quarter. First, we delivered solid net investment income of $0.37 per share, which exceeded our second quarter dividend of $0.30 per share. This extends our record of continuous dividend coverage throughout our more than 10 years as a public company. And today, our Board of Directors declared a third quarter 2022 dividend of $0.30 per share, payable on September 30, to shareholders of record on September 16. Second, our portfolio credit quality remains strong. As of June 30, nonaccruals were just 0.3% of the portfolio at fair value. Our excellent asset quality is a function of our disciplined and consistent underwriting practices. And third, as Phil will discuss in more detail, the strength of our underwriting platform continued to drive solid investment opportunities that resulted in a total of $103 million deployed, a total of nine investments during the second quarter. This is a testament to the strength of the relationships we've developed with a variety of deal sources over our more than two decades in direct lending, as well as the extensive resources and relationships of the broader BlackRock platform. Sales and repayments during the second quarter totaled $82 million, resulting in net acquisitions of $21 million. During the quarter, we continued to exceed our cumulative total return hurdle. As a reminder, TCPC maintains a 7% hurdle rate based on total returns, including realized and unrealized gains and losses and with a cumulative look back. Since 2012, when we took TCPC public, we have generated a 10.7% annualized return on invested assets, and a total annualized cash return of 9.4%. We believe that this is at the high end of our peer group, demonstrating our ability to consistently identify attractive opportunities at premium yields and deliver exceptional returns to our shareholders. NAV did decline 2.1% during the second quarter, primarily as a result of widening market credit spreads, which resulted in net unrealized losses on our existing portfolio. These unrealized losses were partially offset by net investment income in excess of the dividend. Now, I’ll turn it over to Phil to discuss our investment activity and portfolio positioning. Phil?

Thanks, Raj. Despite the public market volatility, we continue to capitalize on the scale of platform, and the rest of our team experienced identify attractive investment opportunities. At quarter end, our portfolio kind of fair market value of approximately 1.8 billion, 89% of our investment were senior secured debt, spread across wide range of industries provided portfolio diversity and minimizing concentration risk. As we've previously noted, our portfolio is weighted towards companies with established business models in less cyclical industries. The portfolio at quarter end consisted of investments in 122 companies. As the chart on the left side of slide 6 of the presentation illustrates our recurring revenue income is distributed broadly across our portfolio and is not reliant on income from any one company. In fact, more than 90% of our portfolio companies each contribute less than 2% of 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 current rising rate environment. Moving on to our investment activity. As one of a small group of breathable lenders capable of providing complete and customized financing solutions we focus on transactions where our US private capital team acts as a lead, COLI or part of a small club of lenders. This enabled us to negotiate deal terms and conditions that we believe provide meaningful downside protection on our investments. robust lender protections, including substantial collateral and tailored covenant packages, are particularly important in periods of economic volatility. We have delivered for borrowers and deal sources on over 1,000 transactions across the US private capital platform. Our extensive long-standing relationships provide us an advantage in identifying and assessing investment opportunities in this current environment. In addition, our industry specialization, which our borrowers truly value, bolsters our ability to assess and underwrite risk. We source an increasingly large set of investment opportunities for multiple channels – and while we've been actively deploying capital in this market, we maintain a very disciplined approach to investing. We regularly review a substantial number of opportunities but only invest in a small fraction of them. General market activity was slower in the first half of 2022, relative to the record levels we saw in 2021 based on M&A and re-financings. However, we actually continue to see strong new deal activity which allowed us to be highly selective. TCPC invested $103 million in the second quarter, primarily in nine investments, including loans to six new portfolio companies and three existing ones. Follow-on investments in existing holdings continue to be important sources of opportunity, accounting for 50% of total dollars invested over the last 12 months, incumbency is an important factor in sourcing investment opportunities and we believe that advantage will only increase, if economic conditions continue to deteriorate. These are companies we already know and understand well, and therefore, are very comfortable in making follow-on investments. As we analyze new investment opportunities, we emphasize seniority in the capital structure, portfolio diversity and transactions where our US private capital team acts as leader Cole. TCPC's largest investment during the second quarter was an incremental first lien term loan to Altice [ph]. The company provides AI-based market intelligence to financial services and corporate clients. Our team was selected to provide the financing given our reputation and scale despite offers from other lenders at lower pricing. BlackRock's U.S. Private Capital team acted as the sole lender to refinance Alpha's existing debt and subsequently to provide acquisition financing. We saw this as an attractive opportunity to invest in a company with robust growth and a highly visible revenue stream from an entrenched blue-chip customer base. Our second largest investment in the quarter was our first lien term loan and revolver to Beqom, a global provider of compensation management software. The sponsor reached out to us directly to provide the acquisition financing, and we've served as the sole lender. We view this as an opportunity to lend to an industry leader with a strong value proposition, high-quality retention rates that provide high revenue visibility and a diverse existing client base. As Raj mentioned, new investments in the first quarter were partially offset by dispositions and repayments totaling $82 million as we had several successful exits and paydowns. These included the full repayment of our loans to Kaseya, Puppet and Core Media. The overall effective yield on our portfolio was 9.8% as of June 30, reciting the benefit of higher interest rates now that substantially all of our loans are above the floors. Investments in new portfolio companies during the quarter had a weighted average yield of 8.9%, exceeding the 8.8 weighted average effective yield on exit condition. Given that 95% of our debt portfolio is floating rate and the majority of our outstanding liabilities are fixed rate, we are well-positioned for further rate increases. We continue to invest selectively maintaining our underwriting discipline and being mindful of the inflationary environment. We focus on companies with established business models that are well-positioned to succeed throughout economic cycles. And our pipeline currently is healthy, and we're sourcing attractive 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 third 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. I'll start by turning to our financial results for the second quarter. We generated strong net investment income of $0.37 per share, which exceeded our dividend of $0.30 per share. Investment income benefited in part from the increase in base rates, and given the majority of our loans reset quarterly, we expect to see further benefits of the rate increases today in our third quarter net investment income. We are committed to paying a sustainable dividend that is fully covered by net investment income, as we have done consistently over the last 10 years. And today, as Raj noted, we declared a third quarter dividend of $0.30 per share. Investment income for the second quarter was $0.76 per share. This included recurring cash interest of $0.61 and recurring discount and fee amortization of $0.04 and pick income of $0.03. Notably, our pick income remains near its lowest level in the last three years. Investment income also included $0.05 of dividend income and $0.03 from accelerated OID and exit fees. As a reminder, our income recognition follows our conservative policy of generally amortizing upfront economics or the lab investment rather than recognizing all of it at the time the investment is made. Operating expenses for the second quarter were $0.32 per share and included interest and other debt expenses of $0.16 per share. Incentive fees in the quarter totaled $4.5 million or $0.08 per share. Net realized losses in the second quarter totaled $18.4 million or $0.32 per share and included $13.8 million from the realization of previous unrealized losses on our investment in Fishbowl as a result of the company's restructuring. Also $13.3 million from the realization of previous unrealized losses on our investment in Avanti, these were partially offset by an $11 million gain from the exit of our investment in CORE Entertainment. Net unrealized losses totaled $3 million and were primarily driven by widening market spreads, which had a negative impact on the mark-to-market of our existing portfolio. The impact of wider spreads was partially offset by a $6.7 million unrealized gain on our investment in Edmentum as well as the reversal of the previously recognized unrealized losses on Fishbowl and Avanti. The net increase in net assets for the quarter was $128,000 or less than $0.01 per share. 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 reverse oversight, including back testing of every disposition against our valuations. Our credit quality remains strong with non-accrual loans at quarter end limited to only two portfolio companies that represent just 30 basis points of the portfolio at fair value and 50 basis points at cost. Now turning to our liquidity. We ended the quarter with total liquidity of $237 million relative to our total investments of $1.8 billion. This included available leverage of $187 million and cash of $49 million. Unfunded loan commitments to portfolio companies at quarter end, equals 8% of total investments or approximately $142 million, of which only $25 million were revolver commitments. Our diverse and flexible leverage program includes two low-cost credit facilities, two unsecured note issuances, and an SBA program. And our unsecured debt continues to be investment-grade rated by both Moody's and Fitch. 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. Additionally, due in part to the opportunistic add-on bond issuance that we executed in August of last year, when we took advantage of an attractive financing environment at the time, we are comfortable with our current mix of secured and unsecured financing and do not have any immediate financing needs. Combined, the weighted average interest rate on our outstanding borrowings decreased to 3.19% 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 and evolving environment. Volatility and uncertainty in the public markets this year has been driven by inflation concerns and geopolitical instability. In periods of economic uncertainty, we are reminded of the benefits of private credit, which has historically performed well throughout economic cycles. To reiterate, our loans are typically at the top of the capital stack, often with collateral protections and with significant equity and/or subordinated capital structured below our investments. Additionally, we structure our loans with meaningful financial and maintenance covenants, and our portfolio remains well diversified by issuer and industry. It is in periods of market volatility that the strength of our diversified strategy and depth of our team's experience is a particular advantage. Our investment team's expertise consists of performing, direct lending and special situations investing. This combination of investing experience, in addition to our focus on transactions where BlackRock either leads or co-lead negotiations on deal terms ensure that we structure loans that are priced appropriately and include adequate downside protection, which has contributed to our team's exceptional long-term performance. And with that, operator, please open the call for questions.

Certainly. [Operator instructions] Our first question is from the line of Kevin Fultz with JMP Securities. Please go ahead.

Hi. Good morning and thank you for taking my questions.

Good morning.

I'd like to start by asking about your thoughts around maintaining the level of the dividend at $0.30 per share. Obviously, over the past two quarters, you've easily covered the dividend and with an outlook for rising base rates driving further net investment income acceleration, it would appear that a dividend increase could be supported. Just curious if you could share some high-level thoughts about how you're thinking about things there.

Yes. Kevin, thank you for the question. And by no means is that a surprise, I think, in the current environment. I would say, as we said in the past calls, our focus is to maintain a well covered and stable dividend, one that has a lot of protection and visibility. I think the environment certainly, for the marginal dollar has more return to it. But when you bifurcate that, a lot of that return is coming through rates, increase in rates that we've seen benefit from and just operating leverage in the portfolio. If you kind of make your way through the one-time benefits and just the run rate of the portfolio, it's higher, it's roughly $0.32. But when we think about any change to the dividend, we really need to make sure that the components that are driving that higher dividend and coverage of it are more visible and stable. And I think for the current quarter, it was just too early to determine if that was the case. And we're continuing to assess it, as we do every quarter with the Board and just kind of making our way through the portfolio and just environmental components. So, it's certainly a timely and relevant question. I think it doesn't change our operating philosophy of what we think is valued in a dividend, which is a stable uncovered dividend. And as we, kind of get our hands around the components that drive the stable uncovered dividend, I think we're going to continue to assess it within the context of the environment and our outlook. Hopefully, that helps give you some clarity.

Okay. That all makes sense. And then just one follow-up, if I can. Originations were understandably on the later side in the second quarter given the slowdown in M&A activity and macro uncertainty. But it appears you're able to find some attractive opportunities still. Can you provide some commentary around expectations for the deal environment and then also net origination activity levels for the back half of the year?

Yes. I think that -- yes, we do continue to expect healthy originations volumes. We're by no means a proxy for the broader private credit market. So understanding that there's been a general slowdown in M&A, refinancing activity in particular, we're seeing a little bit different of a trend for us, which is, we continue to be selective, we continue to play deeply in the industries that we like, and we expect that to continue in the next two quarters. We have deep relationships pretty entrenched in a lot of the sectors we play. We're often being asked to step in early on a lot of these processes, as buyers looking for financing certainty, as part of being able to deliver solid bids themselves. And with the help of BlackRock's broader sourcing platform, it only continues to enhance what we do. Yes.

Okay. Got it. And that's it for me. Congratulations on a solid quarter.

Thank you.

Thank you. Next question.

Our next question comes from the line of Ryan Lynch with KBW. Please, go ahead.

Hey, good morning. The first question I had, you guys talked about benefiting from rising rates. Obviously, there was a big move in the second quarter, which doesn't really flow through as loans reset probably until the third quarter. So could you help -- I'm not sure if you’d run this matter or not, but could you help quantify -- would you think that the benefit from rising rates will be in the third quarter over what it was in the second quarter, kind of, give us a sense of what that impact is.

Yes, Ryan, this is Erik. Thanks for the question. And we do expect to see that flow through even more so in Q3. And as you mentioned, not completely all of the rate increases, because of the lag when they do reset. The table that we put forth in the Q and in the presentation, kind of, gives you a rough idea. If we were to see the full benefit run through in any single quarter. It could be up to $0.05 per quarter. Again, we expect to see a partial benefit from that, so probably more in the range of $0.02 to $0.03 of incremental income for the quarter.

Okay. That's helpful. And the other question I had, I was hoping you could provide some more color on your investment in Juul. There's been some recent news out there where Altria has written their investment down significantly. I think it's written down by 95-plus-percent from their original investment. They just floated down significantly a couple of weeks ago, that investment. The product got banned by the FDA for a minute there. Then got reopened and they’re looking as they would do that -- that application closer. So I'm just curious -- I know you're in a first lien position in that capital structure. But with the equity getting more closer and closer to zero, it seems like, for every few quarters. Is there any capital that's sub your first lien? Is there any sub debt or second lien there, or is the capital stack basically the equity and then your first lien position?

Yes. I can take that one. And certainly, this one has a lot of headlines to it. And you can imagine because of that, we’re little cautious and -- well, we can’t say -- just anticipating a lot of discussion outside of our position. But I would say that just to be clear just to be specific the FDAs actions we are stating to see order in July so that shutdown essentially was state by public but I think overall to answer to question there is senior capital below our first lien and even with the write-down I think in convertible bond anything to the equity itself still has value so its obviously not the value that. But regardless being in the first and our senses and our view is generally that we are in tact at that level even with the headlines and some of the volatility around the name I think we are in a position in comment beyond that other than saying we are first and comfortable in that position. There is senior capital beneath us and what happens in the public eye will probably continue to have headline elements to it. But where we are, we feel comfortable.

Okay. I appreciate the commentary. I understand the sensitivity around not saying too much. That's all for me. I appreciate the time today.

Thank you.

Thank you, Mr. Lynch. Our next question comes from the line of Robert Dodd with Raymond James. Please go ahead.

Hi everyone. Congrats on the quarter. First, a housekeeping one, I've got a couple of others. On the dividend income, which was quite strong this quarter, was there any -- is that a recurring level, or was there any onetime dividend income in this quarter?

Hi Robert, this is Erik. We do have a level of recurring dividend income, which has been approximately $0.03 per quarter. And we do view that as recurring. This quarter, we did get approximately -- a little over $0.02 of what we would consider non-recurring dividend income from 36th Street which has -- continues to perform very well and just made an incremental distribution this quarter.

Got it. Got it. I appreciate that. Thank you. On the -- there was a comment earlier, I can't remember you actually on the other hand talking about the pipeline, the yields are generally in line with divest the portfolio. I mean is that -- what do you seeing implies I mean it is the pipeline is generally in line is that an indication that the in the incumbent positions you're in, et cetera, et cetera. Are you not seeing any spread widening on opportunities in pipeline right now? And is that true, or do you expect to see any spread widening in this environment right now?

Yeah. I'll take that, Robert, and Phil may have additional comments. But I think it's a more nuanced answer, I would say. And it's part of the reason we like private credit. There's from a total return point of view, there's numerous ways to get return, right? And so we are seeing spreads at least stable. And to be honest, in cases, widening at the marginal dollar our target returns and kind of hurdle rates as we make decisions for new investments has gone up. The big chunk of the return increase thus far has been through the reference rate. It's mostly SOFR now versus LIBOR. That has seen a lot of uptick and you've seen that partially flowing through the portfolio and that will continue at these levels. But also the things that don't necessarily emerge upon the current yield partly, it's the OID widening and as a reminder, we don't take that all upfront. We amortize it. And also prepayment structures are -- we're now having more ability to push back and see those become a little more favorable, which you won't get until the back end as those trigger. So, I think the net-net of it is the opportunity set is -- the pipeline is good. The pricing environment is better. The bulk of it thus far has been through the reference rate -- and as we see discussions with borrowers continue, the ability to sort of push back or at least keep spreads at an interesting level and even wider for total return targets that are higher is all element today. Some will emerge upon the close of the deal, some will emerge over the life deal, and some will come at the back end. But I think your intuition around it being a better environment from that perspective is spot on, I would say.

I appreciate that. Sorry, go ahead.

Sorry, Robert, this -- I'll just add that we're in the risk/reward assessment business, and it's not only about the reward. So, we are using this environment to maybe if we're not pushing on price necessarily. We're certainly pushing on elements of risks. So, looking to negotiate whether it's better structures, i.e., lower leverage, I think maybe tighter covenants, maybe other credit documentation enhancements is we're really using the environment to not just focus on pushing price, which, of course, we're always looking to enhance our yields, but also for downside protection to manage risk.

Got it. Yes, it's definitely a risk-reward business. It's not just a reward business. On last one, if I can. I saw in the press release, I think the manager has been when it is a valuation does it me. Can you tell us what that means in a practical sense?

Sure, Robert. What it doesn't mean is that there's any change in the validation process at all. Really, historically, the Board has been the one approving the valuation and with the adviser performing substantially all of the valuation procedures. Now, this just formalizes the process by which the adviser continues to fulfill the valuation policies and procedures. So, no real change in any of the valuation processes.

Okay. Got it. Thank you.

Thank you, Robert.

Thank you, Robert.

Our next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Fishbowl. Hey, guys. That's a controlled company. And what sort of business? Is it a restaurant business or a hotel? I mean, a little color around where it is?

Yeah. Sure. So Fishbowl, full, it's been renamed to Personica recently. It's a software platform for restaurants. So they enhance marketing solutions for the most of the quick service side of the restaurant industry. It really impacted as we've discussed in the past, by COVID with the shutdowns and also experienced management turnover. So at this point, we have gone through the recapitalization of that business. So we co-own the business with the sponsor, which I would note, as part of that process and to use additional capital onto the balance sheet. As well as some – to pay down the debt at par. So we -- challenges certainly remain with this credit -- but we're optimistic given the implementation of a new CEO recently with restaurant technology and expertise. And so we feel like we're better positioned now, especially from a capital structure and any perspective to achieve our growth objectives.

Great. That's it for me. Thank you.

Thank you.

Thank you, Mr. Nolan. There are no additional questions leading at this time. I would like to pass the conference back to Raj Vig for any closing remarks.

Thank you, operator. We appreciate your participation on today's call. I would like to thank our team for all the continued hard work and dedication. I would also like to thank our shareholders and capital partners for their confidence and their continued support. Thanks for joining us. This concludes today's call.

That concludes the BlackRock TCP Capital Corp.'s Second Quarter 2022 Earnings Conference Call. I'll hope you all enjoy the rest of your day.