BlackRock TCP Capital Corp. (TCPC) Q3 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, good afternoon. Welcome everyone to BlackRock TCP Capital Corp's Third 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, [Mia]. Before we begin, I will 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 third quarter ended September 30, 2022. We also posted a supplemental earnings presentation to our website at www. 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 third quarter 2022 earnings call. As usual, I will begin today's call with a few comments in the market environment, as well as highlights from our third 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. The third quarter closed with a continuation of the public market turbulence we have seen across global financial markets this year. It isn't often that both equity and bond markets trade negatively in the same year. However, a combination of geopolitical uncertainty and Central Bank's move to raise interest rates to curb the highest levels of inflation in more than 40 years is driving significant volatility. In this environment, direct lending continues to provide a strong value proposition for both investors and borrowers in terms of safer visible returns and availability of capital solutions respectively. While we are increasingly cautious in this environment, we take comfort in the fact that the investments in our portfolio are structurally senior. Our loans are primarily first lien and are underwritten with meaningful covenants that provide us with an avenue to constructively engage with our borrowers as challenges are foreseen. This proactive approach combined with structural seniority are hallmarks of our strategy and long standing commitment to strong credit quality and principal protection. Our strategy has always focused on poor middle market businesses in diverse, resilient and less cyclical industries. Although large public companies are often perceived to be less risky, the middle market has historically proved to be nimble and resilient during economic downturns. To-date, we are seeing our portfolio companies take actions to address the more challenging market environment. We are observing companies reduce marketing budgets, and other discretionary spending. Certain companies are also raising capital where needed and focusing on acquisitions that continue to drive scale and reduce costs. Turning to our portfolio, we continuously monitor all of our investments and are actively doing so in this environment. While we are seeing some margin pressure as a result of the inflationary environment, and they generally tempered growth outlook, we are very comfortable with our typical position as a senior secured lender and believe our loans are very well covered. We are also seeing a general ability to pass along cost increases to end customers, given any elastic demand for our portfolio companies products and services. Regardless of the market environment, we have always been disciplined with our underwriting standards. We evaluate each borrower's ability to manage in times of duress, through both a forward-looking and a historical lens of performance through prior periods of stress or dislocation. Ultimately, we have confidence in our underwriting our team, and the strength of our diverse portfolio to continue to withstand periods of economic volatility. Let's now turn to our third quarter performance and a few highlights from the quarter. First, we delivered strong net investment income of $0.42 per share. Given the floating rate nature of our portfolio, our net investment income continues to benefit from the increase in base rates through this year. Our net investment income again exceeded our third quarter dividend of $0.30 per share. And we are pleased to announce today our Board of Directors declared a fourth quarter dividend of $0.32 per share an increase of $0.02 payable on December 30th to shareholders of record on December 16. We have always emphasized the stability of the dividend and coverage to our recurring net investment income. And our Board's decision to increase the dividend is an acknowledgement of the increase in the ongoing earnings power of the portfolio and competence and maintaining our continuous track record of dividend coverage. Second, NAV increased 1.1% during the quarter turned by net unrealized gains in the portfolio, and net investment income in excess of the dividend. Net unrealized gains were primarily driven by an increase in the value of our investment in 36th Street and partially offset by decreases in the value of our investments in AutoAlert and Securus as well as the impact of wider market spreads across the portfolio. Third, our portfolio credit quality remains strong and we had no new non-accruals in the quarter. As of September 30th, non-accruals were just 0.3% of the portfolio at fair value. Our excellent asset quality is both a function of our disciplined and consistent underwriting practices and are vigilant credit monitoring. Fourth and as Phil will discuss in more detail, the strength of our underwriting platform continue to drive solid investment opportunities that resulted in a total of 17 new investments totaling $48 million. We also had several prepayments that occurred at the end of the quarter, including the full repayment at par plus accrued of our loan to jewel. As a result repayments during the third quarter totaled $170 million, resulting in net dispositions of $122 million. Finally, we are excited to welcome Karen Leets, TCP's Board of Directors expanding our board to seven members, including six independent directors. Karen is a Senior Vice President and Treasurer of Baxter International, a multinational healthcare company, and she brings a distinguished background and a wealth of governance experience that will further strengthen our Board on behalf of shareholders. TCPC continues to deliver strong results for shareholders, our total return remains above 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 on both the income and capital gains component of the intensity, the cumulative look back. Since 2012, when we took TCPC public, we have generated a 10.7% annualized return on invested assets, a total annualized cash return of 9.4% demonstrating our ability to consistently identify attractive opportunities at premium yields and deliver strong and consistent results returns to our shareholders across market cycles. Now, I will turn it over to Phil to discuss our investment activity and portfolio positioning.

Thanks Raj. Despite the public market volatility that is driving uncertainty in the capital markets, we continue to capitalize on the scale that broader BlackRock, U.S. private capital platform and breadth of our teams experienced identify attractive investment opportunities in this environment. At quarter end, our portfolio of fair market value of approximately $1.7 billion, 87% of our investments were senior secured debt spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. As we previously noted, our portfolio is weighted towards companies with established business models in less cyclical industries. The portfolio at the quarter ended consistent investments in 132 companies an all time high for this portfolio. As the chart on the left side, Slide 6 of the presentation illustrates our recurring income is distributed broadly across our portfolio and is not reliant on income for any one company. In fact, more than 90% of our 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 providing an important benefit in this racing rate environment. Moving on to our investment activity, as one of a small group of reputable lenders capable of providing complete and customized financing solutions, we focus on transactions where our U.S. private capital team acts as a lead COVID or part of a small club of lenders. This enabled us to negotiate deal terms and conditions that we believe provide meaningful downside protection. These include substantial collateral and tailored covenant packages that are important, especially in periods of economic volatility like we are today and expect to be in for the foreseeable future. In addition, our industry specialization, which our borrowers value, bolsters our ability to assess and effectively mitigate risk in our underwriting and were negotiating terms in the credit documents. We have delivered for borrowers in deal sources on over 1000 transactions across the U.S. private capital platform through our more than two decades of lending to middle market companies. Our long standing relationships cultivated over those two decades, coupled with the power of the Blackrock platform provide us with an advantage of sourcing and identifying attractive investment opportunities. We also believe that our ability to source from multiple channels, and our ability to lend and unique or best understood situations are benefiting our pipeline of investment opportunities in the current environment. While we have been actively deploying capital in this market, we maintain a very disciplined approach to investing. General market activity has slowed relative to the record levels in 2021. However, we continue to see strong new deal activity in areas such as add on acquisitions, and opportunities from non-sponsor deal sources. TCPCs invested $48 million in third quarter, primarily in 17 investments, including loans to 14 new portfolio companies and three existing ones. In terms of dollars invested 60% of total investments in third quarter came from our existing portfolio companies. Follow-on investments and existing holdings continue to be an important source of opportunity, accounting for nearly 50% of total dollars deployed over the last 12-months. We believe this incumbency is important advantage in sourcing investments that will only increase if economic conditions deteriorate further. These are companies we already know well and understand well, and therefore comfortable making these follow-on investments. TCPC's largest investments during the third quarter was a senior secured first lien term loan to Achieve, Achieve is a founder led personal finance company that helps consumers overcome and reduce outstanding debt burdens. Given the complexity of the transaction, and our team's experience lending to financial services companies, our team was selected to lead this transaction. And this financing will be used to pay down existing debt and set forth Achieve’s growth initiatives. Our second largest investment in the quarter was a senior secured first lien term loan to Anaconda. With over 29 million active users including more than 700 enterprise customers Anaconda of scale global data science and machine learning platform. BlackRock served as the sole vendor on this transaction, which will go toward refinancing existing debt as well as to fund Anaconda’s growth. As Raj mentioned, new investments in the third quarter were offset by several meaningful payoffs, including Dude Solutions, Foursquare, Jewel and Metric Stream. In light of the challenges Jewel continues to face, we are thrilled and were able to opportunistically exit our loan at par. Total dispositions and repayments totaled $170 million. The overall effective yield on our debt portfolio rose meaningfully from 9.8% as of June 30th, to 11.3%, reflecting the benefit of higher rates during this quarter. Importantly, the full benefit of rates in effect at September 30, will be reflected in our fourth quarter results, given the majority of our loans reset quarterly. Investments in new portfolio companies during the quarter had a weighted average effective yields of 11.3% exceeding the 9.9% weighted average yield on exit positions. Although the private markets tend to be slower to react to changes in the market environment, we are seeing a shift toward an award and vendor friendly environment with improvements in pricing and terms relative to six to nine-months ago. We continue to invest selectively, maintaining our underwriting discipline and being mindful of this inflationary environment. We focus on companies with established business models that are well positioned to succeed throughout economic cycles. And we emphasize the companies that have significant pricing power to pass on increasing input costs, including the cost of capital. It is also important to note that we did not underwrite to perfection, but built in sufficient buffer to ensure companies can withstand higher costs and changes in the market environment without impairing their ability to service our loan. Well, we are seeing a slowdown in deal activity relative to the flurry of deals we saw in the fourth quarter of last year, our pipeline remains healthy. 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 fourth quarter. I will now turn it over to Erik to walk through our financial results as well as our capital and liquidity positioning.

Thank you, Phil. Approximately our net investment income in the third quarter benefit from the increase in base rate so far this year, as well as $0.06 for prepayment income. Net investment income of $0.42 was up 14% from the second quarter, and more than 30% from one year-ago. Net investment income again exceeded our second quarter dividend of $0.30 per share. 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 plus years. Today as Raj noted, we declared a fourth quarter dividend of $0.32 per share, increasing our dividend by $0.02 per share. Investment income for the third quarter was $0.83 per share. This included recurrent cash interest of $0.67, recurring discount and fee amortization of $0.03 and pick income of $0.03. Notably, our pick income remains lower than our historical average. Investment income also included $0.03 of dividend income, a penny of other income and $0.06 from accelerated R&D and exit fees. As a reminder, we amortize upfront economics over that last one investment, rather than recognizing all of it at the time the investment is made. Operating expenses for the third quarter were $0.32 per share, and include his interest and other debt expenses of $0.18 per share. Incentive fees in the quarter total $5.2 million $0.49 per share. Net realized and unrealized gains in the third quarter totaled $1.8 million or $0.03 per share and we are driven primarily by $1.6 million of net unrealized gains on the portfolio. These net unrealized gains in the third quarter included an $18.8 million increase in the value of our investment in 36th Street. Unrealized gains in the third quarter also included at $3.3 million reversal of prior unrealized losses on our investment in June, as we exited our investment on par during the third quarter. Unrealized gains were partially offset by $5.8 million decrease in the value of our investment and AutoAlert and a $2 million mark-to-market decline and devalue our investment in events of technology as well as the impact of wider market spreads across our portfolio. The net increase in net assets for the quarter was $26.2 million, or $0.45 per share. Substantially, all of our investments are valued every quarter, using prices provided by independent third-party sources. These include quotations services, and independent valuation services. And this process is also subjected to rigorous oversight, including back testing of every disposition against our valuation. Our credit quality remains strong with non-accrual loans at quarter end limited to portfolio companies that represent just 30 basis points of the portfolio value and 50 basis points at costs. Before turning toward liquidity, a quick comment on our fourth quarter earnings expectations. While we don't provide forward- looking guidance, it is important to note that our third quarter NII benefited from $0.06 of nonrecurring items. Additionally, while we expect you further benefit from the increase in base rates, we also had a significant amount of paid out that occurred at the end of the third quarter that reduced leverage and the size of our portfolio going into the fourth quarter. Turning for liquidity, we ended the quarter with total liquidity of $351 million relative to our total investments to $1.7 billion. This included available leverage of $246 million in cash $106 million. Unfunded loan commitments to portfolio companies at quarter end, equaled 7% of total investments or approximately $124 million, of which only 20 million were revolver commitments. Our diverse and flexible leverage program includes two low cost credit facilities, two unsecured note issuances and an SBA program. Not only 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 later. Additionally, doing our to be opportunistic add on this show that we have computed in the second half of last year, in which 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 media financing needs. Also, given our higher percentage of fixed rate borrowings, the combined weighted average interest rate on our outstanding borrowings increased only modestly to 3.41% from 3.26% at the end of 2021. Now I will turn the call back over to Raj.

Thanks, Eric. Despite volatility in the broader markets, we are leveraging the power and comprehensiveness of BlackRock platform and our team's deep experience to selectively deploy capital on favorable terms. Our liquidity is strong, and we have ample dry powder to deploy incremental capital, where we see the opportunity. Our investment team’s breadth of expertise consists of performing direct lending and special situations investing, a combination that is particularly well suited for the current environment. Although we remain disciplined in our investment approach and focus on credit quality, we have been able to continually build and diversify the portfolio. The consistency of our performance demonstrates both the efforts of our experience team and the value of our risk reward proposition. And with that operator, please open the call for questions.

Okay. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Kevin Fultz with JMP Securities. Please proceed.

Hi good morning and congratulations on a very nice quarter. My first question is apart from level one on your deal flow activity rate and deal volume. Could you remind me what your historical average deal flow activity rate is and how that has trended recently? And then secondly, could you give us an idea on the total dollar value or number of deals you review on an annual basis?

Yes, sure. Thanks for the question Kevin, this is Phil. So our selectivity rate generally ranges anywhere between 4% to 6% on any given year and that is consistent with the different environment. So we will evaluate anywhere between 1,000 to 1,200 deals a year, on average. And our pipeline today, continues to be healthy. It is not quite as robust, as you can imagine versus let's say, 12-months ago given the environment around refinancings and M&A generally. But for us, it doesn't take a lot for us to stay busy. We have a quite a light funnel and we achieved to do so based on our sources of deals. It is a very wide set of channels, not just sponsored, but also very much focused on the non-sponsored channel where we find real thriving founder for family owned businesses that make for fantastic credits. But it is also important to keep in mind that, quite a number of our pipeline opportunities come through our existing portfolio. This past quarter happened to be quite high at roughly 60%. But generally, anywhere between 40% to 50% comes from our existing portfolio, which is certainly deal flow that we like, because we know those businesses well, we have a great relationship with management. We have seen management execute, and if we are comfortable, then that is putting good money after good portfolio companies.

Okay, that is all really helpful Phil. And then my follow-up is around how you are thinking about leverage in the current environment. Now, I realized you have to sideboard payments during the quarter on the other side origination activity was fairly light. So I'm curious if that was intentional deleveraging of the portfolio or more so driven by the attractiveness of investment opportunity you are seeing in the market?

Yes Kevin, this is Erik, I will take that. In terms of the pace of the repayments, that is probably the one factor that is hardest to predict. But as I mentioned, it was elevated during Q3. In terms of the leverage levels we are comfortable then the portfolio shrank. Having said that it is lower than it is been over the last few quarters. We like that it gives us the flexibility to deploy, we see attractive opportunities.

Okay, that is helpful. And I appreciate your time this morning.

Thank you.

Thank you Kevin.

Thank you. Our next question comes from Ryan Lynch with KBW. You may proceed.

Hey good afternoon. First question I had you mentioned $19 million unrealized gain on 36th Street Capital. I love to hear what drove that increase in that valuation?

Sure, thanks for the question. It was two factors really and again, just a reminder that all of this is through third-party. One is the group has just been performing and the investment very well and we are very pleased with that. That also accreted to a better multiple relative to the to the comps from the valuation providers, they get more credit, just because the performing the consistency of performance. As part of it is also a benefit based on some pending strategic initiatives that are at the company level, and we hope to have more detail to talk to you about that with clarity to hopefully next quarter. But it was a combination of getting the current market valuation and also the company specific strategic benefits.

Okay. And then the other one I had was what is your current weighted average interest coverage on your portfolio and how is that trended let's say over the last six-months?

Yes, I think it is strong. We don't really necessarily give specific numbers because there is a lot of variances in the portfolio that can make an average a little misleading. But I would say on the cash flow coverage on our portfolio, it is roughly 2.5 times and has trended up. Part of that is where we have covenants, many of them will have step downs that require people to or in the case of a coverage ratio step ups that will require people to have credit improvement. And also to the extent these are companies, even if they are growing slower, they are still growing or at worst, stabilizing and seeing a benefit of deleveraging that accretes to the coverage. Obviously, part of the offset is the rate increase. But the number of applicable to cash flow coverage is roughly the 2.5 times range.

Okay, that is helpful. And then my final question was just on dividend and dividend coverage. You guys obviously raised the dividend this quarter, or excuse me, for the upcoming fourth quarter. If I look at that coverage relative to Q3 earnings, which you did say there were a couple of one-time items there was you know, $0.06 of kind of accelerated prepayments versus maybe $0.03 in the last quarter salads, kind of help for their quarter earnings as well as some late quarter repayments, which could pressure earnings. You still had you know about over 130% dividend coverage, which feels extremely high. So can you walk through the thought process of the dividend increase and how you chose the level that you increased it to and where do you guys want to be running out from a dividend coverage standpoint because it feels like there is a lot of room based on the current trajectory.

Yes, let me appreciate that. And let me try to provide some color. There is no science to it. I think, first and foremost, we have stated very clearly that we believe it is important to maintain a stable and well covered dividend. The factors that have been driving the dividend increase through this year are obviously reference rate so far in this, in most cases increases that have been playing through and on a quarterly basis and continue to play through. We don't know where so from those we know that we benefit as it increases, it feels like maybe there is more room, or it is not coming down necessarily, rapidly, but we are not prognosticators on rate. The same time we are now seeing as we invest the marginal dollar. The benefit of investing in higher returning investments, including some spread benefits, being at worst stable, if not increasing. So I think we tried - and then the third thing, obviously, is just the environment, we are very cautious, we are pleased that we have chosen to stay very defensive, both by industry and by structure. Coming into this environment, I think we have always been cautious, but are increasingly so. And so to the extent there is a view that this is lower for longer, there is just an importance of having continued buffer to provide that strong and stable and well covered dividend. Even though at the moment there might be some, additional room. I think we would rather take it up and have confidence that it is well covered and stable, and then continue to reassess as the environment clarifies then do something that requires a reversal or puts pressure on our coverage and our shareholders view of the confidence in our dividend level. I think we took all that into account at a healthy discussion with our board and came to the conclusion that the $0.02 was a good race for this quarter maybe to start but if the current environment was feels that we were sticking to our sort of set our template in our thinking of how we want to level set and provide dividends and benefits to shareholders.

Okay, fair enough on the discussion. That is all my questions I had. Nice quarter and congrats on the exit of Jewel.

Thank you.

Thank you. [Operator Instructions] The next comes from Robert Dodd with Raymond James. Please proceed.

Hi, Just going back to kind of the leverage question like I mean, obviously, you have got available liquidity available capital now, the same terms and structures do seem to be moving in a more lender friendly direction and the pipelines a little bit more maybe modest today, certainly than it was a year-ago. How do you feel - how should we expect you to kind of utilize that that available liquidity. I mean, obviously, you will be opportunistic, but you are going to be a little bit more content to wait to hold that low leverage in this environment is not a bad thing. Especially with rates helping earnings anyway, or, are you expecting to leverage back up in the relatively near-term or maybe wait and take opportunity to take advantage of maybe even more lender friendly terms?

Yes, good question. I will try to provide a little more color. I think part of it just keep in mind is the level and the timing of the pay down was pretty back and loaded including on the last day of the quarter. So there was an impact that just given the cadence of a typical deal doesn't -, it much quicker to have it pay down than to redeploy into the right types of deals, so there is just as a, processing the new capital Cadence and timing. That said, it is great to have capital and available capital to invest in this environment, we are seeing a lot of good opportunities. And so part of it, I think, the answer is partly a bit of both, we will expect to utilize the available leverage to do what we think are very attractive deals with maintaining defensive stance in the industries and the structures that we have worked thus far through other market environments. Whether we decide to maintain some buffer as we approached, really the rating guidelines is a function of both those guidelines that we have to stay on top of, and also our view that, we don't need to stretch in any fashion, because the returns are quite compelling, even at this level. But the additional benefits and leverages is something that we anticipate will be able to utilize. So I think it will be a balancing act, I don't think there is any hard and fast target. We expect it to go up, just because it came down so quickly at the end of the quarter. And we expect that there will be an additional benefit for the read, leveraging to the extent - to the level that we are comfortable with as the environment dictates. With a clear cap on not exceeding any investment grade thresholds as those thresholds whether they move around or not TBD.

Have you received any indications maybe from the rating agencies of, and I'm not necessarily just talking about you, obviously, that would be an industry kind of indications about them wanting to see lower leverage at this point in the cycle in order to maintain. Obviously, you want to keep the investment grade rating, and I suspect you will. But has there been any preliminary feedback from the rating agencies about concern in that regard?

To our knowledge or in our case, I don't want to speak for others, but and I don't say that with any implication that that has been a message or conveyed. But again, we are in sort of a new environment. I think we are just being trying to be cognizant and as informed as we need to be. But to answer your question, no, there hasn't been any feedback on that.

Yes, Robert, I was going to say they recently issued a report on the sector and begun changing the limit. And he said that normally they look at longer term changes in the environment before they change those limits.

Got it, yes. I appreciate it. Thank you.

Thank you.

Thank you. Our next question comes from Christopher Nolan with Ladenburg Thalmann. You may proceed.

Hey, guys, how much spillover income do you guys have?

It is significant. It is about $1.17 on a cumulative basis, $1.17 per share. But that is on a book basis, on a tax basis, it is significantly less given the tax treatment primarily on prepayment income, which gets capital treatment for tax purposes versus ordinary on a job basis.

Got you. And I guess some general question. Last quarter, we are talking about the effect of the supply chain constraints and so forth. Any update to that. I mean, are you seeing, are your companies seeing better supply chain or is it still same issues as before? And that is it for me. Thanks.

Yes, thanks for the question. I think last quarter, the commentary was around acknowledging that there are supply chain issues broadly speaking. However, given our focus at an industry level, on a company level, it is less relevant for our portfolio, it is something we have to be aware of and monitor in a broader context. But we are really investing, for the most part in asset light high IP high gross margin type cash flow businesses. So it is less of something we see in the portfolio, but something that we observe in the market just to be clear.

Thank you. There appear to be no further questions in the queue. So I will now pass it back to Raj Vig.

Thank you. 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, our capital partners and our business partners for their confidence and their continued support. Thanks for joining us. This concludes today's call.

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