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Executives

Richard T. Allorto, Jr. – Chief Financial Officer

Seth M. Katzenstein – Chief Executive Officer & Director

Analysts

Greg Mason – Stifel Nicolaus & Company, Inc.

Jasper Birch – Fox-Pitt Kelton

GSC Investment Corp. (GNV) F1Q10 Earnings Call July 14, 2009 10:00 AM ET

Operator

Welcome to the GSC Investment Corporation’s first quarter 2010 financial results conference call. Today’s call is being recorded. Now for opening remarks and introductions, I would like to turn the conference over to Chief Financial Officer, Mr. Rick Allorto. Mr. Allorto please go ahead.

Richard Allorto, Jr.

Thank you. I would like to welcome everyone to GSC Investment Corporation’s first quarter fiscal 2010 earnings conference call. Before we begin I need to remind everyone that this conference call contains statements that to the extent they are not recitations of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual outcome and results could differ materially from those forecast due to the impact of many factors. We do not undertake to update our forward-looking statements unless required by law. A replay of this conference call will be available from 1 p.m. today through Monday, July 27th. Please refer to our earnings press release for details. The first quarter 2010 shareholder presentation is also available in the investor relation’s section of our website www.GSCInvestmentCorp.com.

I would now like to introduce our Chief Executive Officer, Seth Katzenstein, who will be making a few introductory remarks.

Seth Katzenstein

Thank you Rick. Welcome to all of our shareholders. During the quarter ended May 31, 2009 we observed some stabilization in the credit markets. While we are encouraged by the rebound in the credit markets and the impact that the rebound has had on the valuation of our investment portfolio, the effects of the recession are still working their way through our portfolio companies and we expect that credit events will continue to occur. As a result, we continue to prioritize capital preservation, cash generation and debt reduction.

We believe that our high attachment point investment strategy has positioned us in the best possible way to weather the current market conditions. We have invested more than 73% of our portfolio in senior secured obligations and have invested 16% of our portfolio in the equity trench of a collateralized loan obligation fund commonly referred to as a CLO which is collateralized by more than 90% senior secured first lien term loans.

Before turning the call back over to Rick I would like to briefly touch on two topics. Consistent with the company’s strategy of preserving capital the Board of Directors has decided not to declare a dividend for the first quarter of fiscal 2010. As a regulated investment company we are required to distribute substantially all of our net taxable income to shareholders through the payment of dividends. For fiscal 2009 in order to avoid federal income tax we must declare dividends equal to $6.3 million or $0.76 per share by November 15, 2009 and pay such dividends by February 28, 2010.

However, in the face of working capital and credit facility constraints we feel that the best course of action at this time is to conserve cash. The Board will consider declaring a dividend at its next regularly scheduled meeting in October.

Second, the first quarter unrealized gain on our investment portfolio has not been reflected in the calculation of the borrowing base under our credit facility. At the end of June our credit facility had a borrowing base deficiency caused by adverse events with several portfolio investments. In anticipation of this deficiency we initiated discussions with our lender two months ago regarding a waiver of the anticipated deficiency. We have historically been able to work with our lender constructively but discussions are ongoing.

I will return later with a review of our portfolio but I would now like to turn the call back over to Rick to review our first quarter financial results.

Richard Allorto, Jr.

Thank you Seth. GSC Investment Corp.’s net income for the first quarter ended May 31, 2009 was $5.4 million or $0.65 per share. Our net investment income was $2.6 million or $0.31 per share and our net gain on investments was $2.8 million or $0.34 per share. Our net asset value per share was $8.85 at May 31 compared to $8.20 at February 28.

Our total investment income for the quarter was $4.8 million, a decrease of approximately $1 million versus the first quarter of fiscal 2009. Our net investment income was comprised of $4.2 million of interest income, $0.5 million of management fee income associated with the investment in the CLO and $56,000 of miscellaneous bank interest and fees.

The decrease versus the first quarter of fiscal 2009 is primarily attributable to a decrease in investment income earned during the current quarter which was driven by a decrease in the Libor rate on floating rate investments, a small decrease in the total portfolio size and an increase in the allowance for impaired loans and bonds.

For the first quarter ended May 31, our total operating expenses before expense waiver and reimbursement were $2.4 million and consisted of $643,000 in interest and credit facility expenses, $548,000 in base management fees, $322,000 in incentive management fees, $340,000 in professional fees, $206,000 in insurance expense, $172,000 in administrative expenses and $142,000 in Director’s fees and expenses and general and administrative and other expenses.

We recorded $172,000 in expense waiver and reimbursement for the quarter ended May 31 resulting in total operating expenses after expense waiver and reimbursement of $2.2 million. This is a decrease of $370,000 versus the first quarter of fiscal 2009 primarily attributable to decreases in the interest and credit facility expenses and base management fees which were partially offset by an increase in insurance expenses.

For the quarter we reported net unrealized depreciation of $2.8 million. We experienced net unrealized depreciation throughout our portfolio driven primarily by the increase in price and decrease in yield in the loan markets. We also had several significant write down’s primarily from our investments in the CLO equity, Grant U.S. holdings and Target Group International.

The $2.5 million net unrealized depreciation in our investment in the CLO equity was primarily due to ratings downgrades in the portfolio during the three month period ended May 31, 2009 which will cause the equity distribution on July 20 to be diverted to repay debt and de-lever the CLO. We wrote down our investments in Grant U.S. Holdings and Targets Group as a result of additional credit deterioration. Additional details on the unrealized gains and losses in our portfolio are available in our shareholder presentation which can be found on our website.

During the first quarter we made no investments in new or existing portfolio companies and we had $0.3 million in aggregate amount of exits and repayments resulting in net repayments of $0.3 million. Subsequent to the end of the quarter we fully exited our investment in Blaze Metals and Recycling, receiving total sales proceeds of $1.5 million.

As we mentioned in prior calls, our borrowing limit under the revolving credit facility is based on a dynamic borrowing base calculation that includes factors such as market value, ratings and recovery rates and portfolio diversification. As of May 31, our total collateral balance of $58.6 million versus $57.8 million of borrowings yielded a borrowing base cushion of $0.8 million. During the first quarter we paid down $1.2 million of outstanding borrowings and in July we paid down an additional $4.9 million reducing our total outstanding borrowings to $52.8 million.

Following the end of the first quarter several portfolio investments were either down graded or experienced adverse credit events that resulted in a $17.4 million deficiency in the company’s June 30, 2009 borrowing base which exceeds the company’s unrestricted cash balances of $10.3 million at May 31, 2009. If the company is unsuccessful in obtaining a waiver from our lender and the borrowing base deficiency continues for 30 days an event of default will occur and the lender will have the option to terminate the facility and sell the underlying collateral. As Seth mentioned earlier, we are actively engaged in discussions with our lender to resolve this situation.

As I mentioned earlier, the CLO is in violation of certain of its over-collateralization tests and accordingly will not make its next scheduled equity distribution and will defer payment of subordinated management fees. Available interest spread will instead be used to de-lever and pay down the debt of the CLO until the CLO is in compliance with its over-collateralization tests. Based on our projections we expect the subordinated management fees to be deferred and equity distribution fees to be diverted for at least the next 2-4 quarters.

That concludes my financial review. I will now turn the call back over to Seth.

Seth Katzenstein

Thanks Rick. Before we open for questions I would like to review the composition and performance of our investment portfolio. As of May 31, 16% of our investment portfolio was invested in first lien term loans, 34% in second lien term loans and 24% in senior secured notes which means that more than 74% of our portfolio was invested in senior secured obligations. An additional 16% of our portfolio was invested in the equity trench of the CLO that is collateralized on more than 90% senior secured, first lien term loans.

As I stated earlier, our strategy of investing increases the probability of meaningful recoveries from troubled investments and we believe that this is the appropriate strategic approach for these volatile times. Our corporate debt portfolio is diversified with investments among a variety of industries and issuers. As of May 31, we had 42 corporate debt investments in 22 industries and our average portfolio company investment was $2.9 million. At May 31, the number of portfolio companies on our watch list remained at 18, the same as the fourth quarter of fiscal 2009. However, subsequent to the end of the quarter we exited our investment in Blaze Metals and Recycling, reducing the watch list to 17 investments.

GSC Group has historically been active in work outs of middle market companies and we believe the expertise of our manager in this area will be a key driver in maximizing the value of our portfolio. We have been extremely active recently in the restructuring and workouts of our investments. During the quarter ended May 31, McMillan Companies, a leading Southern California and Texas home builder completed a financial restructuring. The maturity of the notes were extended in exchange for the creation of an interest control account which was established to secure one year’s worth of interest payments.

In addition, McMillan will commence making quarterly amortization payments in November of 2011. GSC Group is the second largest note holder and played an active role in this restructuring. At May 31 our investment in our senior secured note in McMillan had a fair value of $3.8 million or 50% of principle value. Subsequent to the end of the quarter four of our portfolio companies, all of them watch list investments, successfully completed financial restructurings and/or amendments that strengthened their balance sheets and increased the likelihood they will be repaid in full.

As I mentioned on our previous call, on May 1, Jason Inc. senior lenders prevented Jason from paying its quarterly coupon payment on the senior subordinated note. Since Jason is our largest debt investment, this had a significant impact on our June borrowing base. Recently the senior lenders and Jason agreed to a 4-month forbearance. Discussions are ongoing and we will keep you informed of any major developments. At May 31, our investment in the senior subordinated notes of Jason had a fair value of $9.9 million or 71.5% of principle value.

I would now like to say a few words about two other items of interest to our shareholders. As we announced last quarter we retained the investment banking firm, Stifel, Nicolaus & Co. to assist us with identifying and evaluating strategic and refinancing opportunities. We are actively considering and evaluating a number of opportunities to maximize long-term shareholder value. As you are aware, securities laws limit the amount and type of information that we can disclose about such opportunities but we will provide additional information as events warrant. We remind you that there is no guarantee that any transaction will be consummated as a result of the Stifel engagement.

Finally, our investment advisor, GSC Group is continuing to negotiate with its lenders regarding its recent credit facility default. As we have stated previously this default is not related to GSC Investment Corp.’s business or assets and GSC Group continues to provide the investment advisory and administrative services that we require. We believe that so long as GSC Group continues to provide these services its default under its credit facility will not adversely affect the company or our credit facility. Our Board of Directors is monitoring events at GSC Group and will take the appropriate steps to protect the company if necessary.

In closing, I would like to thank all of our shareholders for their support and I would now like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Greg Mason – Stifel Nicolaus & Company, Inc.

Greg Mason – Stifel Nicolaus & Company, Inc.

Can you talk about in the Q you mention a non-accrual reserve account of $300,000 and that was up from none last quarter? Can you walk us through what caused that, how many loans are on non-accrual to fund that?

Richard Allorto, Jr.

For the quarter we had three investments that were officially on non-accrual and those were Brown, Grant and Blaze. Blaze we subsequently did sell after the quarter and we did receive all outstanding interest through our time of ownership but Brown subsequently did not make it’s May 27th payment and Grant subsequently filed for bankruptcy. Additionally, we did establish some partial reserves against some other names that are not in default but in looking at those names we do have some question marks about the collectibility.

Greg Mason – Stifel Nicolaus & Company, Inc.

Just to make sure I am understanding this correctly, that is $300,000 of interest income that you would have received in previous quarters that you are not accruing into income this quarter. Is that correct?

Richard Allorto, Jr.

No. Most of it relates to the current quarter.

Greg Mason – Stifel Nicolaus & Company, Inc.

But that is one of the changes in quarter-over-quarter revenue decline would be this $300,000 that you were getting in previous quarters that you are not accruing?

Richard Allorto, Jr.

That’s correct.

Greg Mason – Stifel Nicolaus & Company, Inc.

To talk about the CLO, is it a 100% cash trap or a partial cash trap in July?

Seth Katzenstein

100% of the cash is being diverted to repay the most junior debt in the capital structure of the CLO. The most expensive debt.

Greg Mason – Stifel Nicolaus & Company, Inc.

In the past you have given us your OC test. I believe in April it was 105.35. Can you tell us what your OC number is today?

Seth Katzenstein

I don’t have that in front of me but I know from trading activity that had not settled on the date of determination for the upcoming payment and subsequent trading activity that we are actually passing all of our over-collateralization tests. We are failing the reinvestment test, which if we are not in compliance would result in a partial haircut of the next distribution but we are currently passing all of our OC’s. The most restrictive of the OC tests we are passing by 15 basis points which is a relatively thin margin and we are working diligently to increase that. We have several things that are haircutting the amount of over-collateralization in the CLO at this time and we do have the ability to sell those assets in order to increase the cushion further.

Greg Mason – Stifel Nicolaus & Company, Inc.

So could you walk us through if you are passing the OC tests why is this going to trap cash for potentially 2-4 quarters?

Seth Katzenstein

We are passing them today on taking into account unsettled trade activity. However, on the date of determination of the CLO which was on July 29th we were not passing those tests and on the date of determination the tests are set on a settled basis. So on that date based on unsettled trade activity, not taking into account we were failing, I might have said it incorrectly a moment ago, however now taking into account all trade activity we are passing. That includes the benefit of the pay down.

Greg Mason – Stifel Nicolaus & Company, Inc.

So you only do this test every six months and that is why it won’t start releasing cash. Is that correct?

Seth Katzenstein

Close. The CLO makes quarterly distributions and the tests are tested monthly or reported monthly. However, they are really only applicable on the date of the payment at least with respect to the distribution.

Greg Mason – Stifel Nicolaus & Company, Inc.

I can understand then why one quarter you wouldn’t pay it because you didn’t pass but why 2-4 quarters if you are back in compliance now with that?

Seth Katzenstein

Good question. The challenge is like our borrowing base the CLO’s are dynamic and the amount of par used in the calculation is based on a variety of factors and we could experience defaults in the future. We certainly project defaults. All CLO managers do and we anticipate some ratings migration because of activity at the agencies or really activity at the companies with the agencies they are [pining] on. Those things could reduce the amount of par available for us in the future. To be conservative we are projecting further par erosion due to downgrades and defaults which I hope doesn’t come to fruition but it could.

Greg Mason – Stifel Nicolaus & Company, Inc.

Can you talk to us on the fair value mark of the CLO at decline during the quarter? I know you marked that based on a modeling basis. What assumptions did you change in your model that caused the mark this quarter?

Richard Allorto, Jr.

We didn’t change any of our default assumptions, future default assumptions. We did lower our recovery rate on those defaults slightly so that had a negative effect. Other than that, it is really a function of these over-collateralization tests and a timing of those future cash flows.

Greg Mason – Stifel Nicolaus & Company, Inc.

On slide nine of your presentation it looks like you changed it a little bit this quarter not mentioning below plan but as I compare it to last quarter it looks like company performance to plan is now below plan is 61.6% which is better than last quarter’s 77.4 but EBITDA 88.2% today are below quarter-over-quarter versus 70.6. Can you talk about how if EBITDA is deteriorating but more companies are performing closer to your plan? Can you talk about that phenomenon?

Seth Katzenstein

Sure. Let’s start with the year-over-year performance. That is a cumulative trend because it is what we are seeing that is going on the economy due to the recession and so as companies look back from 12 months ago they are going to continue to under perform and we are seeing an increasing number of companies under performing over the last 12 months. That is not just in this portfolio. That is across all portfolios. With respect to performance to plan, these are performance to the company’s plan. Historically companies tend to perform closer to plan in the first quarter at least in this environment and in subsequent quarters as the year goes on their under performance to plan tends to increase. If you look back a year ago a substantial number of our companies did better in the first quarter than in the following three quarters. So it is really an issue with what we are comparing to; whether it is year-over-year or to plan and there are some variations in the dynamics associated with those items.

Greg Mason – Stifel Nicolaus & Company, Inc.

So is the performance to plan then based on the new year budget that you put together or based on at the time of origination?

Seth Katzenstein

First of all these are based on the companies plans, not our plans. So guidance and projections we have been giving from the companies that we have investments in and they are based on the budgets they have provided us from the most current year. These are not budgets or projections from three years ago when we made the original investment.

Operator

The next question comes from Jasper Birch – Fox-Pitt Kelton.

Jasper Birch – Fox-Pitt Kelton

You I believe have a 200 basis point penalty on your credit facility, is that correct?

Seth Katzenstein

I believe that is correct. Yes.

Jasper Birch – Fox-Pitt Kelton

Would that 200 basis points be beginning when it is actually in event of default so in 30 days or is that currently at a higher interest rate?

Seth Katzenstein

If I understood the question correctly, it was difficult to hear you, upon event of default that increasing rate would be applicable.

Jasper Birch – Fox-Pitt Kelton

Could you give us the pro forma borrowing base using May values?

Richard Allorto, Jr.

I believe that is in the Q. It might not be. Pro forma using the May values it does not cure the deficiency but we do pick up about $2-3 million as a result of the appreciation.

Jasper Birch – Fox-Pitt Kelton

How would each dollar of divestiture impact your borrowing base?

Richard Allorto, Jr.

Currently the June borrowing base we have a relatively large excess concentration within the CCC basket. So depending upon the type of divestiture, if it is a CCC asset it is very beneficial because we are currently getting no credit for those CCC’s within the borrowing base calculation. If it is a non-CCC asset, it actually has a slightly negative impact because the CCC basket is measured on the total portfolio. So the total portfolio would be decreasing, making the basket even smaller and possibly making the excess concentration even larger.

Jasper Birch – Fox-Pitt Kelton

Is there any way you could provide any color on what you are looking at in terms of increasing divestiture and whether you are offloading those CCC’s or are you thinking about holding on to them?

Seth Katzenstein

As Rick and I mentioned we did exit Blaze Metals and Recycling after the quarter which was $1.5 million in proceeds and a watch list investment and we were pleased with the value we received for that investment. We are looking at several other portfolio companies to divest of but you need to keep in mind this is a portfolio of middle market loans and almost by definition are illiquid and they trade by appointment so we are selective in what we are able to sell and we may not receive the value that we think the credits are worth because of the illiquidity issue. There are a handful we are looking at selling and if we can achieve the appropriate value we will do that.

Operator

The next question comes from Greg Mason – Stifel Nicolaus & Company, Inc.

Greg Mason – Stifel Nicolaus & Company, Inc.

Just a follow-up on that last question, can you quantify with your exit of Blaze Metals was that a CCC investment and does that give you another $1.7 million or whatever you exited at?

Seth Katzenstein

I believe yes it was a CCC and yes, that is correct. It would knock that $17.4 million deficiency down by…

Greg Mason – Stifel Nicolaus & Company, Inc.

By whatever cash you received?

Seth Katzenstein

It would knock it down by what Blaze is being carried at within the borrowing base.

Greg Mason – Stifel Nicolaus & Company, Inc.

If it was CCC though did you say it was carried as a zero? Is that correct?

Seth Katzenstein

That is correct.

Operator

There are no further questions. I would like to turn the conference over to our speakers for any additional or closing remarks.

Seth Katzenstein

Thank you for joining us today. We look forward to speaking with you next quarter.

Operator

That does conclude our teleconference. Thank you for your participation.

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Source: GSC Investment Corp. F1Q10 (Qtr End 05/31/09) Earnings Call Transcript
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