TCP Capital Corporation's CEO Discusses Q1 2013 Earnings Results - Earnings Call Transcript

| About: TCP Capital (TCPC)

TCP Capital Corporation (NASDAQ:TCPC)

Q1 2013 Earnings Call

May 09, 2013 01:00 pm ET


Jessica Ekeberg – Head-Investor Relations

Howard Levkowitz – Chairman, Chief Executive Officer

Paul Davis – Chief Financial Officer

Raj Vig – President


Greg Mason – KBW

Stephen Laws – Deutsche Bank

Chris Kotowski – Oppenheimer

Boris Pialloux – National Securities


Good day, ladies and gentlemen, and thank you for standing by. Welcome everyone, to the TCP Capital Corporation’s First Quarter 2013 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’d like to turn the call over to Jessica Ekeberg, a member of the TCP Capital Corporation Global Investor Relations team. Jessica, please proceed.

Jessica Ekeberg

Before we begin, I would like to note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance. Forward-looking statements involve risks and uncertainties, and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today and are subject to change without notice.

During today’s call, we will refer to a slide presentation which you can access by visiting our website, Click on the Investor Relations link and select Events and Presentations. Our earnings release and 10-Q are also available on our site.

I will now turn the call over to Mr. Howard Levkowitz, Chairman and CEO of TCP Capital Corp.

Howard Levkowitz

Thanks, Jessica. I would like to thank everyone for participating in today’s call. I am here with our President and COO, Raj Vig; our Chief Financial Officer, Paul Davis; and other members of the TCP Capital team.

Yesterday, we issued our earnings release for the first quarter ended March 31, 2013. A supplemental earnings presentation is posted to our website. We will refer to this presentation throughout our call. Today I will provide an overview of TCPC’s investment activities and performance. And then, Paul will provide more details on the numbers. I will then return with some further prospective before we take your questions.

I would like to start by reviewing a few key highlights from the first quarter. First, we are pleased to report that our portfolio generated net investment income of $0.49 per share after preferred dividends and incentive compensation. Second, we are raising our quarterly dividend to $0.36 per share up from $0.35 per share in the previous quarter.

Third, our earnings per share was $0.60 and our net asset value increased sequentially by 1.4% to $14.91 per share. Our estimated net asset value as of April 30 was $15.14 per share. Fourth, we deployed $40 million in new investments during the quarter and $62.5 million during the first five weeks of the second quarter.

Now moving on to a summary of the market environment in the first quarter, we saw a lower level of activity during the first quarter following a surge in deal activity at year-end. Activity levels across our markets were slow at the beginning of the quarter, but our deal flow began to increase later in the quarter. Over the last four quarters, we invested over $325 million on a gross basis and over $100 million on a net basis. We continue to focus on allocating our capital to income producing securities as 98% of our new investments in the quarter were in the form of senior secured debt.

Spreads and covenant packages in the middle market continue to be more attractive than those in the large leverage loan market. However, the tight spreads in the broadly syndicated market have influenced terms in our market. Against this backdrop, we took a highly selective approach that choosing investments and we’ll continue to carefully analyze each opportunity through our intensive and proven due diligence process.

Turning now to TCP Capital’s first quarter performance, TCP Capital generated $0.49 per share in net investment income after preferred dividends and incentive compensation. And we will pay a quarterly dividend of $0.36 per share at the end of June.

We would like to emphasize that the first quarter net investment income significantly exceeds our regular second quarter dividend. This margin of coverage demonstrates the earnings power of our portfolio.

In addition, our first quarter net increase in net assets from operations was $0.60 per share. Paul Davis, our CFO, will cover this in more detail. For those viewing our presentation, please turn to slide 8. Our highly diversified portfolio was in good shape at the end of the quarter with a fair value of $510 million invested in 54 companies.

On slide 9, you can see the continued transformation of our portfolio since the beginning of 2012. During the first quarter we maintained our high percentage of debt investments as well as the percentage invested in senior secured debt and floating rate investments. At quarter end, approximately 93% of the portfolio was invested in debt securities, 96% of which were senior secured loans.69% of the debt positions were in floating rate debt, 96% of which had interest rate floors.

During the first quarter we invested approximately $40.3 million in five different transactions. These include four follow-on investments in existing portfolio company positions and one new company.

Approximately $32 million was invested in senior secured floating rate loans. We also invested approximately $7 million in senior secured notes. Follow-on investments in existing portfolio companies are often attractive opportunities given our comfort and familiarity with these businesses and their prospects.

Our three largest investments during the quarter include; a $15 million senior secured loan to a leading regional telecommunications company in which we have been investing for almost a decade; a $14 million senior secured loan to a leading technology-focused HR service provider, which was part of a larger $125 million commitment by our affiliate; and $7 million of senior secured notes to a natural resources company.

New investments made in the first quarter had a weighted average effected yield of 10% compared to a 12.1% average yield for the investments that we exited during the quarter. We elected to make loans at lower yields in companies to which we have existing relationships rather than stretch for transactions that do not meet our criteria during a slow quarter.

In addition, the average yield for investments that we exited was higher than in past quarters, largely due to the repayment of our largest single loan which had an above average yield contributing about 100 basis points to the 12.1%.

Because of these two factors, this is the first quarter since our IPO where we have not experienced a trend of increasing yields. Even so we are pleased with the yield differential between our originations and repayments over the last several quarters. Our overall effective portfolio yield was 11.1%, which is only 20 basis points lower than a year ago.

In the first quarter, we exited $51 million in investments largely due to re-financings. These included; a $19 million senior secured loan to STG-Fairway, for which we provided new acquisition financing; a $17 million senior secured loan to Sky Funding which re-financed after its parent became investment grade and the non-call term in our loan expired; and a $9 million senior secured loan to Integra Telecom. Our prepayments created significant additional income, which Paul will address as he provides a more detailed report on our first quarter financial results.

It is important to note that the prepayments are lumpy and should not be annualized. After Paul’s comments, I will provide some additional perspective on what we are seeing in the second quarter then we will take your questions. Paul?

Paul Davis

Thanks, Howard. We are pleased with our results for the three months ended March 31, 2013. As you can see on slide 8, total investment income was approximately $16.9 million. Per share total investment income was $0.79 which included $0.14 of additional income from prepayment premiums and the realization of unamortized discounts on prepay debt investments. Total investment income also includes $0.01 per share from other amortization of upfront fees and acquisition discounts as well as PIK income of $0.01 per share.

As mentioned in prior calls, it is our policy generally to amortize upfront economics on debt investments rather than recognize the income all at once at the time the investment is made. Total investment income is net of $0.6 million of depreciation expense from aircraft we own and lease or $0.03 per share, which caused an equal amount of cash flow from those leases to be non-taxable.

Total operating expenses for the quarter including interest were approximately $2.9 million or $0.13 per share. We also accrued dividends on the preferred equity facility of $0.4 million or $0.02 per share. Our annualized operating expense ratio including interest and the preferred dividends but excluding incentive compensation was 4.1% of average net assets.

We began incurring incentive compensation on January 1, 2013. Incentive compensation is payable only on net investment income after preferred dividends and net realized gains reduced by any net unrealized losses subject to the total return hurdle of a cumulative 8% annually.

Incentive compensation payable for the quarter was $2.7 million or $0.13 per share, which was calculated by multiplying net investment income after preferred dividends by 20%. No incentive compensation was paid on realized gains since no dispositions occurred during the quarter at a price above their value on January 1 when the incentive compensation period began other than repayments that generated additional interest income.

For book purposes, our reserve amount is also calculated based on any additional incentive compensation that would have been payable had we liquidated that net asset value on the balance sheet date. This reserve is not payable unless the associated gains are actually realized when compared to net investment values on January 1, 2013, or cost if acquired later, and is subject to reversal. At March 31, this reserve amount was approximately $471,000.

Net investment income before dividends on the preferred equity facility and incentive compensation was approximately $14.0 million or $0.65 per share. Net investment income after preferred dividends and the incentive allocation in reserve was approximately $10.4 million or $0.49 per share. This amount, once again, significantly exceeds our increased current quarterly dividend of $0.36 per share.

The difference between our net investment income after preferred dividends and incentive compensation of $0.49 per share and the net increase in net assets from operations of $0.60 per share resulted from net realized and unrealized gains of approximately $2.4 million or $0.11 per share due to mark-to-market adjustments in our overall portfolio.

As a reminder, over 95% of our portfolio is priced at least quarterly using market quotations or nationally recognized third-party valuation services. As of March 31, 2013, we continue to have no investments on non-accrual status. After paying our first quarter dividend and special dividend, which totaled $8.6 million, we estimate we closed the first quarter with tax basis undistributed ordinary income of approximately $27.4 million.

Available liquidity at the end of the quarter including net cash and unused capacity on our credit facility totaled approximately $57 million. Our leverage was approximately 0.6 times net debt to common equity. However, our deployment in the second quarter to date has been significant.

TCP Capital continues to benefit from an attractive operating expense structure. As noted, total first quarter expenses including all costs of leverage but excluding incentive compensation were 4.1% of average net assets on an annualized basis. This is due in part to TCP Capital’s low cost of leverage as highlighted on slide 12.

Our total weighted average interest rate on amounts outstanding on our combined leverage facility was 0.9% at the end of the quarter. Amounts drawn on our preferred equity facility accrued dividends at the rate of LIBOR plus 85 basis points and borrowings on a revolving credit facility bear interest at a rate of LIBOR plus 44 basis points, which is our incremental borrowing cost.

Now, let’s turn the call back over to Howard.

Howard Levkowitz

Thanks, Paul. I will conclude with a few comments on what we are currently seeing in the market and then open the line for questions. So far, in the second quarter of 2013, we are seeing a robust pipeline of deal flow and a wide range opportunities across a variety of industries. We continue to see a steady flow of recapitalizations, re-financing and other new loan activity motivated by debt maturities and middle market companies in need of more flexibility.

That being said, we are taking a selective approach to new investments due to lower market spreads and some spillover in our markets from looser terms on broadly syndicated loans. We expect that Dodd-Frank, along with the increased capital requirements of Basel III will continue to fuel opportunities as banks and other traditional lenders continue to be strained in making certain middle market loans.

All told, we are cautiously optimistic that the investment activity will remain robust in 2013. Through May 3, 2013, we have invested approximately $62.5 million in six senior loans, to five new and one existing portfolio company with an effective yield of approximately 9.3%.

Expanding our earnings by effectively putting our existing liquidity to work and optimizing our portfolio is our primary focus. Now, that we have deployed our IPO proceeds and reduced our equity exposure, we are also evaluating potential options to expand our capital base and liquidity in a prudent manner so that we can continue to capitalize on the attractive opportunities we are seeing. The expansion may include activity on both sides of the balance sheet.

We have an extensive history of investing in companies that are positioned for long-term value creation with sustainable competitive advantages and that generate significant cash flow and/or have significant asset coverage. We set the bar high with our intensive due diligence process and remain selective in our choice of investments with a focus on both achieving high risk-adjusted returns and preserving capital. We believe our portfolio is well positioned to deliver strong risk adjusted returns for the remainder of 2013 and beyond.

Before we take your questions, I would like to remind you of the attractive structural features of our company that Paul described earlier. Our origination income recognition practices are conservative. We have a low-cost structure and a shareholder-friendly fee structure.

In addition, we have voluntarily locked up our own personal pre-IPO holdings of approximately $10 million in investments in TCP Capital for three years from the IPO and several members of the management team and the board of directors have bought shares in the market throughout last year.

We believe that management’s interests are clearly aligned with our shareholders. We would like to thank our shareholders for your investment and confidence in us including your support for all of the proposals recommended by management in connection with our proxy and annual meeting.

And with that, operator, please open the call for questions.

Question-and-Answer Session


Understood, sir. (Operator Instructions). All right. And it looks like our first question will come from the line of Greg Mason with KBW. Please go ahead. Your line is open.

Greg Mason – KBW

Great. Thank you, gentlemen. I appreciate you for taking my questions. Could you talk a little bit about the new investments you’ve done so far in the second quarter? I was a little surprised to see the 9.3% yield relative to your, your current portfolio is 11.1%. Kind of why is that yield going down and is that temporary? Maybe you could make structural changes to improve that or how should we just be thinking about the pipeline overall going forward from a yield to maturity perspective?

Howard Levkowitz

Thanks for the question. The pipeline in Q2 and what we’ve invested in so far is robust and diverse. We’re seeing a lot of deals, we’re passing on a lot of deals and the ones that we’ve elected to do, we found attractive on a risk-adjusted basis. In some cases, we prefer to have a senior investment, most of our investments are senior secured or being a first lien rather than have several hundred basis points of additional yield.

We’ve been early pioneers in the uni-tranche structure doing our first such deal in 1999. We think those are very attractive. We continue to do them. We often take a second position in those. But in some cases, we also think it makes more sense to simply take an entire first lien piece instead of the strip.

We have a huge advantage. We have the lowest cost of funding of any BDC that we’re aware of. Now we paid 90 basis points for leverage and we also have generally a low cost structure. So we’re able to do these deals in this market and still make very good spread and returns on them.

We are doing other deals at higher returns. I wouldn’t assume this is a full-time or permanent change. You’ll see quite a variety of different deals and spreads when we report the second quarter. And so that I wouldn’t assume that this is going to be the case going forward. It is indicative of a number of the things that we’ve done so far in this quarter.

Greg Mason – KBW

Great. I appreciate the color. And on that low-cost leverage, I believe the credit facility with maturity date of July 14, if I remember correctly, do you have the option to extend that one year and is there anything that could prohibit you, assuming you want to do that from extending that out to 2015?

Howard Levkowitz

So, the option requires lender’s consent. We expect that on our next quarter’s call, we’ll have a lot more to say about how we’re looking at our various leverage facilities.

Greg Mason – KBW

Okay, great. And then, we’re starting to see some other BDCs enter the aircraft leasing space. This is a space I know you guys have been in a long time. What kind of opportunities are you seeing in that market today?

Howard Levkowitz

Sure. We’ve been in that market since 2003 and we do it on an opportunistic basis. We think it’s a great place to make money, if you have the skill set, the contacts, the knowledge and you’re patient. We didn’t do any deals in the sector in the last couple of quarters and our investments in the sector have always been lumpy because we wait for good opportunities and make them when the deals come along as opposed to trying to allocate a certain amount of capital to the sector.

It’s clear that there are a number of new entrants. We tend to focus on a particular niche in the market. Older aircraft are most of our investments, although one investment that was repaid during this quarter was actually for newer aircraft. That was a little bit more of a unique situation with the leasing company.

But it’s also not clear that these entrants are dramatically changing the complete complexion of the industry. I think one of the other factors that’s happening is, in the US, the domestic carriers have much better balance sheets. And we’ve always looked at the planes first under the assumption that any airline can be challenged.

But given the different economics of the industry is experiencing, there’s more capital in general going into the sector and there’s more comfort with the underlying risk of the airlines themselves. So, we will continue to deploy capital opportunistically, but you may not see anything for a while.

Greg Mason – KBW

All right. Great. And my last question, can you talk about what you’re seeing just in the underlying general fundamental trends of your portfolio businesses in terms of top line growth or decline and bottom line growth or decline?

Raj Vig

Sure, Greg. It’s Raj. I’ll try to address that. I think when we approached the underwritings, a lot of what we do is focus on the safety and the downside protection as we’ve talked about, and part of that means not sort of buying into a outsized or a big growth picture. Where we do get credit for things that will flow into earnings, many times it’s on the cost side of the structure, realizable cost especially with experienced operators.

In that context, I would say that the portfolio and you cannot necessarily overly generalize the portfolio. Credit stats are pretty stable. Where we have underwritten to those costs, realized cost savings, they generally come through. I think that as we talked about in the last couple of quarters, our macro outlook remains cautious, so we’re not getting overly aggressive on the growth picture.

On a macro side or as it feeds down into individual companies, part of that means being more defensive in terms of the structure but also being more defensive in terms of how you see the out year and out quarter earnings. But to answer the question, they’re generally stable and healthy because we’re buying into the cost side versus the growth side.

Greg Mason – KBW

Great. Thanks guys.

Howard Levkowitz

Thank you.


Thank you sir. Our next question will come from the line of Stephen Laws with Deutsche Bank. Please go ahead. Your line is open.

Stephen Laws – Deutsche Bank

Thank you. Good afternoon. A lot of my questions were hit on with the last part of the prepared comments and previous questions but wanted to – just seeing a pretty good shift from fixed to floating rate as far as the mix of portfolio and maybe it ties to the most recent comment about being a little more defensive.

But is that a conscious decision on your part? Is it a competitive standpoint where the rates you guys offer are more compelling against competitors on the floating side in the fixed or is it the borrowers that have a preference there? Can you maybe talk to that mix shift and I guess kind of the competitive environment around the floating rate loans?

Howard Levkowitz

Sure, thanks for the question, Stephen. We tend to prefer floating rate. Predicting interest rates over a long period of time is difficult. We’ve clearly been in a period with extremely low rates on an absolute basis. And it sounds like we’ve really been going down for most of 30 years and in the current environment, the fed has made clear that they intend to keep them low for a while. But we think, at some point, there’s a risk of rates going up and we’d rather protect ourselves by having floating rate most of the time.

So our approach tends to be to prefer floating rate instruments. We give up something in terms of short-term coupon for doing so, but we’re protected on the upside for when rates do go up and we think they, likely at some point they will. We’re not sure when but when it happens. It will probably be at the time that people aren’t expecting it and it might be dramatic. So from our perspective it’s really a positioning of portfolio insurance.

There’re some borrowers who want fixed rate and they insist on it. And so we’re not absolute on it. When it’s really important to somebody, we’re willing to do that. And in some cases, deals that involve other parties are restructured that way. But, we tend to prefer going with the floating rate just as a matter of portfolio management.

Stephen Laws – Deutsche Bank

Great. And, again, you guys addressed most of my questions on Q2-related deployment and investment capacity and option there. So, congrats on a nice quarter and thanks for taking my questions.

Howard Levkowitz

Thank you and thanks for joining us today.


Thank you, sir. Our next question will come from the line of Chris Kotowski with Oppenheimer. Please go ahead. Your line is open.

Chris Kotowski – Oppenheimer

Hi. Good afternoon. Maybe you said it and I just missed it. But in the investment income, where there prepayments or prepayment, I mean, benefits? How much were they?

Paul Davis

Yes. They were, the prepayment income during the first quarter was about $0.14 per share or $0.11 per share after incentive compensation.

Chris Kotowski – Oppenheimer

And just I just can take that and multiply that by 21.4 million shares and...

Paul Davis


Chris Kotowski – Oppenheimer

In dollars? Okay. All right. And then, I’m wondering when you talked about the yield of the new investments going down from 11% in the current portfolio to 9% and change, 9.3% I think you said, is there a way to segregate how much of that is sort of tighter pricing and how much of it is the move into floating rate versus fixed?

Howard Levkowitz

I don’t think that that segregation would necessarily give you an accurate picture of what we’ve been doing with the portfolio. Each one of these situations is situational. Some cases, as I noted earlier, we’ve just opted to be all in a first lien as opposed to a uni-tranche structure.

Some cases are probably giving up some yield for the floating rate and some are simply situations where we’ve been willing to take a lower rate in this environment. So I’m not sure that dividing it in that way would be useful. But there really is a very wide variety of different structures in there.

And one other thing I just want to note. You’d asked Paul about the income that we got from repayments. We’re very pleased with the amount that we generated this quarter, but this is a lumpy number and we wouldn’t encourage anybody to annualize it. It was high in Q4. It was high in Q1. It comes from funding at a discount, getting paid at a prepayment premium.

And we’re pleased, in one of those cases, we were then able to convert into a new loan with the same borrower as part of an acquisition financing, for which we’ve made a large commitment $125 million across our platform and so that was an all-around win. But these repayments are lumpy. When we recognize them is when the cash has been paid back, but I wouldn’t necessarily annualize that number from quarter to quarter.

Chris Kotowski – Oppenheimer

All right. And then, you referenced to $62.5 million of new loans, I assume that’s a gross number. Have prepayments also kept pace in the second quarter?

Howard Levkowitz

The prepayments have been lower this quarter. We are doing some optimization with our portfolio looking to exit a few of our lower yielding positions on an opportunistic basis. So I would note that in Q4 our portfolio turnover was lowest that it’s been since the company has been public in Q1 and that trend is continuing going forward into Q2.

Chris Kotowski – Oppenheimer

Okay. I think that’s it for me. Thank you.

Howard Levkowitz

Thanks Chris.


Thank you, sir. Our next question will come from the line of Boris Pialloux with National Securities. Please go ahead. Your line is now open.

Boris Pialloux – National Securities

Hi and thanks for taking my questions. I have two quick questions, the first one is about your NAV. You mentioned in your press release that your April NAV was $15.14. Is there any item that really drove this increase?

Howard Levkowitz

No. There are no singular items that have driven it. The TCP Capital has a very powerful earnings model and so a significant portion of that was simply driven by our operating income. And some of it was driven by appreciation, but it was generally across a number of positions as opposed to any single item.

Boris Pialloux – National Securities

Okay. And second thing is actually regarding your aircraft business. I mean I guess you have most of your borrowers are in the US and, let’s say, Air Canada is trying to securitize some of its airplanes. Is there a market abroad to actually land and do exactly what’s happening within the US?

Howard Levkowitz

Yes, there is a robust market for aircraft financing as the international treaties put lenders and lessors in a pretty good position in terms of pursuing their aircraft or their loans globally, although as they’re applied in different countries, it’s different.

But there’s a very active market for that, and there are a lot of opportunities. We’ve primarily focused in TCP Capital, of course, entirely focused on domestic situations. It’s certainly easier when the planes are in the United States although some of these aircrafts can be flown even by domestic carriers out of the country.

Boris Pialloux – National Securities

Okay. So, directly, you could, I mean nothing prevents you to actually participate in securitization cost of a company like Air Canada or a European company?

Howard Levkowitz

That is correct. I would note that the transactions we’ve done to date though have been a series of bilateral deals that we’ve primarily done with the airlines themselves. In some cases, we’ve acquired planes. In other cases, we’ve done it from the airlines themselves. So, we haven’t usually been part of multi-party transactions. The loan that was paid off this quarter to Sky Funding involved us and other party. But usually we do these things on our own as opposed to participating in some larger securitization transaction.

Boris Pialloux – National Securities

Okay, excellent. Thank you for the color.

Howard Levkowitz

Thank you, Boris.


Thank you, sir. And presenters, at this time, I’m showing no additional questioners. Like I said, we’ll conclude our time for questions. I’d like to turn the program back over to Howard for any additional or closing remarks.

Howard Levkowitz

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


Thank you, presenters. And thank you, ladies and gentlemen. Again, this does conclude today’s conference. Thank you for your participation and have a wonderful day. Attendees, you may now all disconnect.

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