Medley Capital's CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: Medley Capital (MCC)

Medley Capital Corporation (NYSE:MCC)

Q3 2013 Earnings Conference Call

August 2, 2013 10:00 am ET

Executives

Brook Taube - Chairman, Chief Executive Officer

Richard Allorto Jr. - Chief Financial Officer, Chief Compliance Officer, Secretary

Analysts

Ron Jewsikow - Wells Fargo

Greg Mason - KBW

Mickey Schleien - Ladenburg

Douglas Harter - Credit Suisse

Casey Alexander - Gilford Securities

J.T. Rogers - Janney Capital Markets

Operator

Good day, ladies and gentlemen and welcome to the Medley Capital Corporation’s Third Quarter Fiscal 2013 Financial Results Conference Call. Today’s call is being recorded for replay purposes. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference.

(Operator instructions)

This conference call may contain statements that, to the extent they are not recitations of historical fact, constitute forward-looking statements. Actual outcomes and results could differ materially from those forecast, due to the impact of many factors. The Company does not undertake to update its forward-looking statements, unless required by law. The third quarter 2013 investor presentation is available in the Investor Relations section of the company’s website at www.medleycapitalcorp.com.

I’d now like to turn the call over to the Company’s Chief Executive Officer, Mr. Brook Taube. Please proceed, Mr. Taube.

Brook Taube

Thank you very much and we appreciate you all taking the time to join us this morning. As a quick agenda, for the call we are going to discuss the following first, we will discuss our dividend, which the Board increased to $0.37 for the quarter ended June 30. Second, we will give you an update on originations and the portfolio including a review of the origination activity for the quarter end, our current outlook. And finally, we will provide you an update on our SBIC activity during the quarter and discuss liquidity and capital availability for new investments.

On the dividend we are pleased to report that the Board of Directors has increased the dividend to $0.37 for the quarter ended June 30. The dividend will be payable on September 30, to shareholders of record on August 23. As we have stated in the past, we expect net investment income will meet or exceed the current dividend as we look forward assuming we are able to deploy capital as planned.

Now on the origination, during the quarter, ended June 30, we originated $119 million that was in 8 new investments and 2 existing investments. We received amortizations and repayments totaling $22.5 million which resulted in net portfolio growth of $96.5 million. We are pleased with the second calendar quarter origination volume and our pipeline remains strong.

With respect to pricing for the non-sponsored investment opportunities we have seen stable pricing and continue to find attractive risk adjusted returns in the market. Our deal flow remains strong and we expect to continue to deploy capital in a steady consistent manner for the balance of 2013.

On the portfolio which consist primarily of senior secured loans, the portfolio remain stable and well-diversified with 56 portfolio companies now across 23 industries at an average position size of $12.3 million.

Our expectation is that we will continue to diversify as we grow the overall size of the portfolio. And in addition, we expect to increase the percentage of floating rate loans in the quarter’s ahead. During the quarter, we added one loan to non-accrual, Geneva Wood Fuels, which represents 0.6% of the overall portfolio as of 6/30. As we stated on our prior call, this company is currently in a sale process and we expect the process to be complete in the current calendar quarter.

Turning now to the SBIC. During the quarter, we invested the balance of the $50 million in regulatory capital that is in the SBIC subsidiary, now we completed our first draw down of SBIC leverage which totaled $5 million. The large portion of our current pipeline qualifies for the SBIC and we expect to continue to draw the SBIC leverage in a consistent measured manner in 2013.

During the most recent quarter, we completed our first examination by the SBA and as a result, we now have access to a total of $50 million of SBIC leverage. This is referred to as the first turn of leverage on our $50 million of regulatory capital. We anticipate gaining access to the second turn, an additional $50 million of leverage. Once the first turn is fully drawn and invested that would give us a total of $100 million or the full two turns of leverage on our current $50 million of regulatory capital.

We may in the future increase the regulatory capital of the SBIC to the maximum of $75 million that would be an increase of $25 million and that would allow us to borrow an incremental $50 million which are being leveraged to $150 million for the SBIC subsidiary.

During the quarter, in addition to the SBIC financing we increased commitments to our revolving credit and term facilities by $31 million which brings total commitments to $345 million. As of June 30, we had drawn $54.7 million of capital on our revolver and I would like to point out that the combination of the lower cost revolver availability and the SBI term financing provides us with low cost financing capacity for future investments as we grow the portfolio.

I would now like to turn the call over to Rick Allorto, our Chief Financial Officer to review the third quarter financial results.

Rick Allorto Jr.

Thank you, Brook.

For the three months ended June 30, the Company’s net investment income and net income were $12 million and $3.2 million or $0.37 per share and $0.10 per share respectively.

The net asset value per share was $12.65 at June 30, compared to $12.73 at March 31. For the quarter, total investment income was $23.6 million and was comprised of $20 million of interest income and $3.6 million of fee income.

Total operating expenses were $11.6 million and consisted of $6 million in base and incentive management fees, $4 million in interest and financing expenses and $1.6 million in professional fees, administrator expenses and general and administrative expenses.

For the quarter, the Company reported net unrealized depreciation of $8.7 million and a net realized loss from investments of $137,000.

As of June 30, the Company’s total debt outstanding equaled $278.2 million including $54.7 million outstanding on the revolving credit facility and our debt to equity ratio excluding SBIC debt was 0.65 times.

That concludes my finance review.

I will now turn the call back over to Brook.

Brook Taube

Thanks Rick.

Overall, we are pleased with the performance of the first half of the calendar 2013. The team remains focused on originating a portfolio of high quality loans at attractive yields. So, we will continue to generate a stable and consistent dividend for our shareholders in the quarters ahead.

Thank you all for joining. And we can open the call now for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

And your first question comes from Jonathan Bock from Wells Fargo. Please proceed.

Ron Jewsikow - Wells Fargo

Good morning and thank you for taking my questions. This is Ron Jewsikow for Jon Bock. Brook, real quick, the income as a percentage of overall revenue continues to trend higher and I believe your book origination fees upfront and in the income when fees are received. One question, how do you look at the steady state income kind of including -- excluding fees relative to the fee income and what would you say the stable cash flow on your portfolio is excluding fees?

Brook Taube

Thanks for the question. I’m just going to reiterate that we expect net investment income, we’ll exceed, neither exceed our dividend over time.

Ron Jewsikow - Wells Fargo

Okay. And then just kind of one question, I noticed on there was a balance sheet entry for $1.6 million in fees receivable. And the first question kind of led to that is, is that included in the $3 million fee number this quarter?

Brook Taube

Yes.

Ron Jewsikow - Wells Fargo

Okay. And could you kind of walk through, how is it possible to book the income if you haven’t received yet in cash?

Brook Taube

The transaction was completed and so the fee was earned.

Ron Jewsikow - Wells Fargo

Okay.

Brook Taube

We are on accrual basis.

Ron Jewsikow - Wells Fargo

All right. And then just one question as it relates to the SBIC. I appreciate the color on the available leverage currently and where it’s trending going forward, could you give an idea on the sense of deployment or utilizing a leverage going forward?

Brook Taube

Yes, I think -- we don't, I don't want to get too specific. But, I think we said on a prior call that we would expect to allocate somewhere around 25 million per quarter.

Ron Jewsikow - Wells Fargo

All right. And I have one final question. And I know the fixed floating asset mix kind of skewed heavily towards fix this quarter, is that something you expect to continue going forward kind of that you utilized the SBIC to match funding or is this (job) kind of --

Brook Taube

We now look at the SBIC in isolation. As I said on the call; we expect floating rate assets to increase over time. I think on any given quarter, I don't think folk should infer too much from any specific quarterly activity. I’ll stick with the overall comment that we will over time be increasing floating rate assets.

Ron Jewsikow - Wells Fargo

All right. Thanks. Thanks for the color guys.

Brook Taube

Sure.

Operator

Thank you. Next question comes from the line of Greg Mason from KBW. Please proceed.

Greg Mason – KBW

Great. Thank you. Good morning, guys. Could you talk about on the eight new loans you made this quarter, how many of those were sponsored versus non-sponsored?

Brook Taube

I don't the number right in front of me. Let me just try to track that quickly.

Greg Mason – KBW

Sure. While you are taking a look at that -- the PDF on the website which breaks out all of your investment backlog and summary looks like it cuts off the yield to maturity, can you talk about the yield to maturity on the backlog of deals that you’re currently looking at?

Brook Taube

Yes, I would say right now, yields in the market have been stable. So, we produced assets just over 13% this quarter, the amortizations and prepayments rolled off at approximately 12.5% so that was actually a slight yield pick up on that portion that rolled.

In terms of the market, on our backlog, the yields are at or above and one comment I have I believe made in the past is that indicative pricing on a backlog does not tell you where it will close. But that it’s been stable and it’s higher than our current booking would lead us to believe -- leads us to expect the pricing is now stable and that’s what we’re seeing in the current quarter.

Greg Mason – KBW

Great. And then also looking at that backlog, several of those deals look larger than definitely your average being around $12 million one close to 40 and several in the high 20s, low 30s million dollar size, can you talk about, is there any shift to going on for kind of the change in larger size?

Brook Taube

No, there has not been. Again, I think as you are aware, we have total investment capability, we got private fund. And so I would not expect to see a significant shift in the average deal size in the balance of this year.

Greg Mason - KBW

So, the buy side that would go into your portfolio, the BDC, it’s probably not representative of the whole amount in that backlog chart?

Brook Taube

I think that’s correct.

Greg Mason - KBW

Okay, great. And then one question, I’ll hop back in the queue. Last quarter, you talked a little bit about Calloway Labs, it looks like you added to it this quarter, given that it’s one of your largest investments, can you give us an update on that credit and just thoughts about if that has a potential for non-accrual down the road or just what are you seeing in the trends there?

Brook Taube

Yes, I mean this, as we talked about in the previous call, this has been a tricky position. The quick recap that, what’s driving the performance issue was a continued reimbursement rate cuts among the commercial providers, we’ve also have seen customer attrition resulting from increased competition from some of the larger industry players. The team that has come in is now has been in place if there is cost cutting initiatives that are resulted in somewhere around 13 or 14 of annual cost savings. So, and the integration of the Willow Street Lab is going forward.

So, we’re watching it carefully. We expect to have more information. There is a plan for this to be back on trend revenue and EBITDA. I think as the balance of 2013 rolls through and we see the turnaround plan taking a root would be able to give more color. But at this point, it’s for sure the trickiest position. But over the quarter, there has not been a material change.

Greg Mason - KBW

Great. I appreciate the color. Thanks guys.

Operator

Thank you. Next question comes from Mickey Schleien from Ladenburg. Please proceed.

Mickey Schleien – Ladenburg

Good morning, Brook. Actually following up on Calloway, can you talk about your general policy of allowing a borrower to restructure their loan into pick while they are struggling, where do you draw the line on allowing that to happen given the risk profile?

Brook Taube

I’ll try to comment generally Mickey.

Mickey Schleien – Ladenburg

Okay.

Brook Taube

Part of our business as I think people know well is that we’re active and were hands on. Our team is 54 people and many of our 30 investment professionals have deep experience from prior life in restructuring. That’s a very important tool for us. So, as you would likely expect in the credit business should know every position is going to go swimmingly all of the time. What we did in this case is a couple of way that you can support borrower that faces hurdles. They can raise equity. They did. They can bring in restructuring groups, work therefore in Calloway they did and the borrowers can provide liquidity and support for the company which we did.

And I think to think about the two ways, you can provide liquidity. One is fund a lot more capital, we see that that occurs, that’s not our preference, another way is to let interest accrue. So, in this case we have effectively provided liquidity, we’ve done on purpose. We’re supporting the borrower. We have reason to believe it can turn although as I said it has not but we’re watching it. As from the policy perspective, you should expect every time that we look at a situation and do anything that involves providing liquidity that there is a thorough re-underwriting and a very careful decision that’s being made.

So, this situation is at this point per quarter-over-quarter above stable, we’re watching it carefully and we’ll definitely keep you all posted like I said 2013 going forward.

Mickey Schleien – Ladenburg

Okay. That’s a great explanation. Thanks Brook. And in relation to that, there is two other positions that looks like, I’d like to know whether they’re experiencing fundamental problems or whether the markdowns were for technical reasons. So, they are Exide and the Modern Video.

Brook Taube

Sure, let me take them in order. On Exide, I may have my date wrong but if we invested in 2012 and our basis was in the low 80s, the idea there was we were going to earn par plus interest. At the time there was a recovery underway and the company was actually experiencing contract wins. And as we came into 2013, on this position there were significant input cost issues that lead to lower fundamental performance that was exacerbated, this is public knowledge by their issue in California where they had to close down a recycling facility. So, there was liquidity issues that resulted.

These combinations lead to a bankruptcy filing this June. And obviously, the mark-to-market today is lower. At this point, we look at sort of a -- on re-underwriting and recovery expected outcome. The company has approximately $1.9 billion of assets and round numbers $1.1 billion of total debt at filing.

So, it’s the market around sixty. So that is a mark-to-market adjustment based upon publicly traded numbers. Our recovery now at the mid 80s, with over 18 month recovery has an IRR expected total return at this point in the mid 20% range. So at where we sit today we’re comfortable with the position, I think the overriding comment will be obviously they say mark-to-market adjustment. It’s going to take time, but we like our position where we are today.

Did that answer it on Exide for you?

Mickey Schleien – Ladenburg

No. And you are still accruing on Exide right?

Brook Taube

Yes, it’s during the bank (inaudible), it is accruing.

Mickey Schleien – Ladenburg

Okay. Modern Video?

Brook Taube

In Modern Video experienced fundamental deterioration, there was a decline in the enterprise value, it was related to credit. There was lower performance at the company. It’s really a top line issue. What’s happening at the company is, they are implementing cost saving measures approximately $4 million. And they have one critical business that we expect would get revenue and EBITDA back to and 2013 plan number. And then for actually the 2014 fiscal which is their main year.

They are also in discussions. I can’t comment on specifics but with a large strategic partner on an initiative that would add revenue in EBITDA leveraging their existing capacity. But based upon the fundamental performance, the independent valuation resulted in a enterprise price value decline. Does that answer it for Modern?

Mickey Schleien – Ladenburg

Yes. And I will ask my last two questions and I had the same sponsored, non-sponsored question, which I would like to ask understand. So, my other two are, can you refresh our memory as to your target leverage including the SBIC. And is there any chance that Medley Capital, the BDC will acquire a stake in Sierra Income’s external manager?

Brook Taube

There are no plans on the latter. With respect to Sierra, in terms of leverage we said publicly and we will stick with it that our target on balance sheet ex-SBIC is 0.6 to 0.7. We ended the quarter at 0.65 and I saw top end of that range. We have a little bit of flexibility. And the SBIC we have access to. So that is not a change, I’m just reiterating what we said before.

Mickey Schleien – Ladenburg

Okay. And the sponsor and non-sponsor?

Brook Taube

I am just locating the number. In number it was half sponsor and half non-sponsor this period, in terms of notional value, I am getting that for you.

Mickey Schleien – Ladenburg

Okay. Thanks Brook.

Operator

Thank you. Your next question comes from Douglas Harter from Credit Suisse. Please proceed.

Douglas Harter - Credit Suisse

Thanks Brook. My questions were asked and answered.

Brook Taube

Thank you.

Operator

Thank you. Next question is from (Carl Joseph) from Stephens. Please proceed.

Unidentified Analyst

Morning, guys and thanks for taking my question. Most of mine have been answered. But, Brook, where do you guys expect your cost of funds to be on the SBA debt, I know you haven’t locked in the rate yet. But just given the recent increase in treasuries, where you guys see your cost of funds at?

Brook Taube

Well, I wish, I can predict where rates are going. But I think -- I will -- I will let you guys make the call of where the proxy rate will set next time the SBA fixes.

Unidentified Analyst

All right. And then in terms of revenues in EBITDA for the portfolio just on an average basis, what sort of trends you guys are seeing there?

Brook Taube

Yes. I mean on a revenue basis, I think like I don't know the exact GDP. I think it’s mid-1.5%, 1.7% GDP. Our revenues are tracking slightly above GDP -- last quarter and that was consistent with last quarter was slightly higher on a trialing latest 12-month basis on the last call.

In terms of cash flow, our EBITDA is flat. So, slightly below GDP. I would characterize these as not significant deviations but in line which -- as our portfolio grows, I would expect, we would look more like that -- more consistent with what you would be seeing kind of top line and cash flow in the broader market.

Unidentified Analyst

Got it. Thanks a lot for answering my questions.

Operator

Thank you. Next question comes from Casey Alexander from Gilford Securities. Please proceed.

Casey Alexander – Gilford Securities

All right, good morning. Brook, you said that looking forward that the non-sponsored market sort of rate wise looks steady. So, what I want to know is by default, are you saying that the sponsored market seems to be squeezed, we’ve heard a lot about competition from banks, from BDCs getting more aggressive, has the sponsored market become much more competitive?

Brook Taube

Yes, let me answer it in two parts. I think what we’ve seen is yield actually have not been coming down, this quarter. There was a compression in the Q1 calendar, I say Q2 calendar we did not see it. What we are watching for carefully and we’ve seen a little bit of -- is more aggressive structure. That it would be interesting to watch, we’re watching it carefully, do you see more aggressive behavior as capital comes in on the credit side. So, the comment on the quarter is no. We have not seen it. We are watching it carefully but I was really trying to just draw the distinction, that we’re still seeing 250 to 300 basis point excess return in the non-sponsored deal flow.

Casey Alexander – Gilford Securities

I mean, are you, does that mean if yields are not coming down, the covenants are getting lighter or that there is a higher proportion or lower attachment rate to second liens things like that, is that how you would characterize it?

Brook Taube

Yes. That’s what I characterize us watching carefully. I don't think I can make a statement. There has been a significant shift in Q2. But we’re watching it to see how that trend continues here through the middle of the year and into the back half of 2013.

Casey Alexander – Gilford Securities

Okay. Secondly in the $8 million plus in unrealized losses for the quarter, how much of that would be assigned to credit markdowns versus how much of that would be assigned to general market movement?

Brook Taube

Two/thirds was related to specific credit and a third was related to market.

Casey Alexander – Gilford Securities

Perfect. Okay. Thank you very much.

Operator

Thank you. Next question comes from Greg Mason from KBW. Please proceed.

Greg Mason – KBW

All right. Just want kind of quick follow-up on the SBA, once you deploy the first $50 million of debentures, do you have to be reviewed by the SBA again to get the second $50 million or do you just get to roll right into it?

Brook Taube

I wouldn’t characterize it as a review. I think you have to apply. Since we have not applied before, I don't want to comment on how long that would take but as it’s my understanding that we make an application and that you reasonably expect to get that second turn in very short order.

Greg Mason – KBW

Great. Thanks. Appreciate that.

Operator

Thank you. The next question comes from J.T. Rogers from Janney Capital Markets. Please proceed.

J.T. Rogers – Janney Capital Markets

Thank you. Good morning, Brook. Just I had a couple of questions, I guess, first, just want to get a little clarity on Geneva, I believe Geneva is still on cash accrual, are they continuing to pay interest on-time or is that, or you just expecting or you accruing interest that you expect to get on the sale?

Brook Taube

Well, let me just -- can you ask that question one more time?

J.T. Rogers - Janney Capital Markets

Sure. I think that just looking in the Q, Geneva is on pick non-accrual but it isn’t on cash non-accrual, are they continuing to pay cash interest?

Brook Taube

Yes, the cash portion is current and the pick portion is non-accrual for Geneva.

J.T. Rogers - Janney Capital Markets

Okay, great. And then I guess that sort of the same question on Exide, I mean they went into bankruptcy, they are still on the accrual as of at the end of the second quarter, would you expect to continue to recognize interest income from Exide?

Brook Taube

On Exide, there are an accrual for the portion of the claim piece. So, rough as just you can assume 60% of the current mark is accrual and the portion that is not in the claim at the place is not accruing.

J.T. Rogers - Janney Capital Markets

Okay, great. And then just looking also at the Q, there is a little changes in the disclosures, in past quarters you have had LTV for each of the investments and I didn’t see in the Q this quarter is that something that you are going to be discontinuing?

Brook Taube

And we have a new format, I would characterize it as industry confirming standard, it’s easier to read and it has more industry standards disclosures. So you should expect the current disclosure to be the format going forward.

J.T. Rogers - Janney Capital Markets

All right. And then sort of a last question, do you guys have a view on the macro environment, just sort of generally I mean looking through your new investments, there is some restaurants in there, some commercial sort of consumer exposure, as well as, tail loan to JD Norman’s is a fairly large loan to what I understand to be a small company. Are you guys seeing things improve, is that allowing you to take maybe more risk than you would if you saw a flat to down economy?

Brook Taube

I don’t know, we don’t’ really have a comment on the overall market. I wouldn’t read too much into the origination in any given quarter above our perspectives. Again, we are going to stay diversified. We obviously like our positions that we are putting on the book. And we do actually remain very optimistic about being a creditor in a low growth environment. It’s a very good backdrop for us. We have seen stable return opportunity that is the flip side, if it were all after the races, I think you see more pressure on yield. So, at this point we feel comfortable and we are in a nice balanced environment that’s favorable to be a credit (inaudible).

J.T. Rogers - Janney Capital Markets

I guess maybe another question, definitely that’s in a question is -- do you all need to see economic growth for the majority of your portfolio to continue to perform?

Brook Taube

We underwrite assuming a stable growth, like growth. So, the answer, I guess is no.

J.T. Rogers - Janney Capital Markets

Okay, great. Thanks for taking my questions.

Brook Taube

Thanks J.T.

Operator

Thank you. I’d now like to hand back to Mr. Taube for closing remarks.

Brook Taube

Well, thank you all for joining. It was a good quarter here at Medley. We appreciate the support and as always we are available for any follow on questions. Thank you all. We will talk to you next quarter.

Operator

Thank you. Ladies and gentleman that concludes your call for today, you may now disconnect. Thank you for joining. And have a good day.

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