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Medley Capital Corporation (NYSE:MCC)

F1Q2014 Earnings Conference Call

February 07, 2014 10:00 AM ET

Executives

Brook Taube – Chief Executive Officer and Chairman of the Board of Directors

Richard T. Allorto, Jr. – Chief Financial Officer, Chief Compliance Officer and Secretary

Analysts

Jonathan G. Bock – Wells Fargo Securities, LLC

Troy L. Ward – Keefe, Bruyette & Woods, Inc.

Mickey M. Schleien – Ladenburg Thalmann & Co., Inc.

John Heck – Stevens Investment Bank

Casey J. Alexander – Gilford Securities, Inc.

Patrick D. Buckley – UBS Securities, LLC

Operator

Good morning, ladies and gentlemen. Welcome to Medley Capital Corporation’s First Quarter Fiscal 2014 Financial Results Conference Call. Today’s call is being recorded for replay purposes. At this time, all participants are in listen-only mode. (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 first quarter 2014 investor presentation is available in the Investor Relations section of the company’s website, www.medleycapitalcorp.com.

I would 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 welcome everybody to Medley Capital Corporation’s quarterly earnings conference call. We appreciate everyone taking the time to join this morning. Our quick agenda, first, we’ll discuss the recently declared dividend of $0.37 for the quarter ending December 31. Next, we’ll provide an update on originations and our portfolio including a review of the origination activity for the quarter and our current outlook. Third, an update on our SBIC activity as well as our overall liquidity and capital availability for new investments and finally, we’ll review the financial results for the quarter ended December 31.

On the dividend, on February 5, the Board of Directors declared a dividend of $0.37 per share for the quarter ended 12/31. The dividend will be payable on March 14 to shareholders of record on February 26. As we’ve 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. On originations, during the quarter, we originated $160 million in 12 new investments and five existing investments. Amortizations and repayments totaled $92 million during the quarter resulting in a net portfolio growth of $68.6 million. We are very pleased with this quarter’s origination volume. We experienced an increase in amortizations and repayments during the period compared to prior periods. However, we were able to deploy capital and produce our largest quarterly growth originations.

A quick comment on pricing, pricing on the non-sponsored investment opportunities remain stable and we continue to find attractive risk-adjusted returns in the market. The deal flow remains strong and we expect to continue to deploy the capital in a steady and consistent manner.

Turning now to the portfolio, again it consists primarily of senior secured loans. The credit performance is stable and well-diversified. We have 63 portfolio companies now across 25 industries. So the average position size as of 12/31 was 13 million. Our expectation is that we will continue to diversify as we grow. And as I mentioned on prior call, we intend to increase the floating rate portion of the portfolio. During the past quarter nearly 80% of new origination volume was floating rate. We expect to increase the overall floating rate portion of the portfolio in the quarters ahead. And as of December 31, the percentage of our portfolio in floating rate assets was approximately 60% with the balance in fixed rate assets at approximately 40%. On the credit side, on balance the portfolio remains stable.

Turning now to the SBIC excuse me, for the quarter ended December 31, we drew down an additional $14 million of SBIC leverage to end the quarter with a total of $44 million drawn on our SBIC leverage facility. As of December 31, the subsidiary had $75 million invested in seven portfolio companies with an average position size of $10.7 million. A large portion of the existing pipeline qualifies for the SBIC and we expect to continue to draw the leverage in a consistent and measured manner throughout 2014.

And as we’ve communicated in prior calls, we may in the future increase the regulatory capital at the SBIC subsidiary to $75 million, that will be a $25 million increase in the current $50 million to regulatory capital and that would allow us to borrow an incremental $50 million from the SBA bringing the total leverage available to $150 million for the subsidiary. So as of today, our liquidity for new investments including the proceeds from our recent equity offering is approximately $300 million and this includes $56 million of undrawn SBIC leverage that’s available today.

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

Richard T. Allorto, Jr.

Thank you, Brook. For the three months ended December 31, the company’s net investment income and net income were $17 million and $14.3 million or $0.42 per share and $0.36 per share respectively. The net asset value per share was $12.68 at December 31, compared to $12.70 at September 30. For the quarter, total investment income was $31.7 million and was comprised of $25.1 million of interest income and $6.6 million of fee income.

Total operating expenses were $14.6 million and consisted of $7.9 million in base and incentive management fees, $4.5 million in interest and financing expenses and $2.2 million in professional fees, administrator expenses and general administrative expenses. For the quarter, the company reported net unrealized depreciation of $2.8 million and a net realized gain from investments of $45,000.

As of December 31, the Company’s total debt outstanding equaled $363 million including $96 million outstanding on the revolving credit facility, $120 million term loan payable, $103.5 million in notes payable and $44 million of SBA indentures. The Company’s debt-to-equity ratio, excluding SBIC debt was 0.63 times. As of today, our liquidity for new investments is approximately $300 million and this includes a $56 million of undrawn SBIC leverage.

That concludes my financial review; I’ll now turn the call back over to Brook.

Brook Taube

Thanks Rick. Again, we’re very pleased with the performance in the first fiscal quarter for our 2014, the team remains focused on originating a portfolio of high quality loans at attractive yields that will generate a stable and consistent dividend for our shareholders in the quarter ahead. We’d like to thank all the shareholders for their continued support and we can now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jonathan Bock from Wells Fargo Securities. Please proceed.

Jonathan G. Bock – Wells Fargo Securities, LLC

Good morning and thank you for taking my questions and congratulations on a great quarter indeed. One quick question as it relates to Calloway Labs, this is a notice – this was a markdown and Brook we’ve mentioned it in the past and this has obviously been an investment that you’ve mentioned is tricky. Can you walk us through, now that it’s a 17% pick investment, how is this pick accrued into income, is it accrued at the full rate or at the mark?

Brook Taube

At the mark.

Jonathan G. Bock – Wells Fargo Securities, LLC

Okay, great. Then the only other question I have is, so as you accrue at the mark and we noticed a slight decline quarter-over-quarter, could you give us and investors maybe a sense of how you look to realize value from this investment in the future, given that you are not new to this, it’s just a matter of understanding given the fact it’s a bit sizable relative to some of the other investments in the portfolio?

Brook Taube

Sure, but thanks for the question Jonathan. Look we do look forward at some point to giving positive news on Calloway; we don’t have it at this point. Revenues, has still been the broader backdrop of the Callaway situation as there is competitive pressure from the larger toxicology labs. The Company has faced customer attrition as well as lower sample volumes. I’m happy to report that there are new customer wins. We are watching that carefully, but we haven’t had the conversion of these sort of new accounts as rapidly as necessary for sort of revenue producing. So we are watching that carefully.

I’ve told everyone that there is a team in there looking carefully at it, we’re in constant contact. The new management team appears to be well positioned, but on balance the performance is not better than it was in the past. Now in terms of how we would expect to get value from this that’s a priority at Medley, we have skill to do that, we have an expectation that we will.

There are several strategic initiatives, I’m not in a position to disclose specifically, but we have strategic initiatives underway, and I think most people that are aware of how this business works would imagine the various outcomes. So we are carefully paying attention to it, I don’t want to give you a timeline at this point, but it’s on the front burner and we’ll keep everyone posted.

Jonathan G. Bock – Wells Fargo Securities, LLC

Fair enough, thank you so much. And maybe turning to fees for a moment, obviously these do ebb and flow and the question would be that with roughly let’s say $3 million of origination and $3 million of prepayment. Looking forward, is it possible that the velocity of the portfolio will persist in a manner where you’ll see about a 50/50 split between origination and prepayment fee or based on call protection, et cetera that you might have on newer investments. Would it be fair to say that that origination versus prepayment fee split will be somewhat different? Can you give us some color on the velocity of the portfolio and how you see that translating into your income statement from a fee perspective over the next several quarters?

Brook Taube

Got it. Well, first of all I think it’s tricky to comment on what the future will hold that’s not something we are comfortable doing generally. I will characterize this quarter as abnormally high prepayment. My general sense looking forward is that we would expect a more normal not abnormal split, I think that was uniquely high, we got paid a lot of fees that’s part of the business, we have call protections, prepayment penalties, et cetera getting in money back and increasing returns. I don’t have the exact number, but to give you a flavor of the realizations they are put on as you know at our book yields of approximately 12%, 13%, 14% than the average in the past year or two.

The IRR and the realizations was well into the mid 20% IRR. So getting your money back with fees is a good thing in our business, the question about what then is about how you can redeploy it and if you can attract the deals. So prepayments are not a big issue today as we look at our pipeline and opportunity, they are not a big issue as we look at the secular trends in the part of the market that we are focused on. So we are more favorable than ever towards the opportunity to originate sensible investments right now. So hopefully that gives you a little bit of color that prepayments are not an issue if you can re-originate. And secondly I will make the general comment; my expectation is that this quarter was an outlier in terms of the percentage of prepayments that we would reasonably expect.

Jonathan G. Bock – Wells Fargo Securities, LLC

Okay that’s a great color and then one last question as it relates to equity issuance, I think first on everybody does appreciate a management team that chooses to leverage the balance sheet as you have and/or doing and as we kind of look at a recent equity issuance that you’ve completed this current quarter with all-in required returns on assets to breakeven at roughly around 13-ish percent perhaps a little bit lower depending on the more leverage one uses within SBIC. Maybe just kind of giving us a sense of confidence of what you’re seeing in the market today in terms of all-in IRRs if you are at a 20% number. How can one look at your ability to more than over earn. Would someone look at it as a required rate of return in that 13% range on your assets?

Brook Taube

Well I don’t actually have a comment on your assertion about the required yield. Taken your number at face value, I would just say, we are going to issue where we think we can invest capital on accretive basis for shareholders.

Jonathan G. Bock – Wells Fargo Securities, LLC

I appreciate it. Thank you very much.

Operator

Your next question comes from the line of Troy Ward from KBW. Please proceed.

Troy L. Ward – Keefe, Bruyette & Woods, Inc.

Great. Thanks for taking my questions, real quick, Brook can you just speak a little bit on what you are seeing here so far in the first quarter, I know a lot of times as we roll the calendar into a New Year, we start to see a drop-off stuff got pulled into the previous year, can you speak to what you are seeing in the current quarter activity?

Brook Taube

A stator quarter for us. I mean it’s a little bit early in the quarter to say what we would expect. I think we are right in line here based upon the number of deals and the volume that we are seeing.

Troy L. Ward – Keefe, Bruyette & Woods, Inc.

Okay and then the last question I have, which is on the SBIC. Can you remind us, what hurdles you kind of have to clear in order to get the additional 25 – clearance to put additional $25 million of capital into the SBIC facility?

Brook Taube

There are no hurdles. It’s simply the pace at which we originate. We don’t need the capital there. We put – we have $50 we’ll use the two turns of leverage and then we’ll inject the extra regulatory capital and there is no hope to getting that invested or the leverage.

Troy L. Ward – Keefe, Bruyette & Woods, Inc.

Okay, it’s great, all right thanks guys.

Brook Taube

Thanks, Troy.

Operator

Your next question comes from the line of Mickey Schleien from Ladenburg. Please proceed.

Mickey M. Schleien – Ladenburg Thalmann & Co., Inc.

Good morning. Brook I was hoping you could give us a little background on the quality of deal flow, as it breaks down between your dividend recap, refi, growth capital, et cetera, and also how are the deal flows breaking down between sponsored and non-sponsored, and what trends you are seeing in the sponsored might fit in terms of pricing in terms?

Brook Taube

Sure, I would say – I’d characterize it as consistent. We have volume coming from all of the channels, and the use of proceeds is pretty evenly split on balance. I don’t have the break-out Mickey and I can get it back to you, but we basically – we’re seeing capital use for growth opportunities and refinancing. We are not focused on the dividend recap. Selectively it does occur, but the bulk of our capital is to either expand or to refi. And we are seeing it broad-based.

One comment I’ll make on the volumes, the average size of this quarter of the deal we saw was almost brought on with prior quarters. So in the market we are in, we are seeing demand at the same size. Now with respect to pricing, again I’ve mentioned in past calls, we track origination volumes that would be all of the deals we see very carefully and we have indications on those. So while those are prices that print in the market, if you keep a consistent database on those through time, you get a real flavor on the movement in that, that group in quarter-to-quarter.

So we actually saw a slight uptick in pricing, I wouldn’t say it was significant, but it’s the first quarter in four quarters where we’ve seen pricing moving up not down. And that is assuming sort of a constant structure and constant leverage that’s not driven by a shift in risk.

So as we sit here today without commenting on the economic backdrop, I think some of the risk off in the market, the lack of issuance at the same rate in our market sector as well as formation of capital in the private market, which we watch carefully that may describe some of the pricing stabilization in trend, but we are looking – we think it’s favorable. I think secondly I’ll make the comment, reducing continued pressure in the sponsor side and we do look at the larger cap market in particular that’s obviously been under enormous pressure.

So if you look today at Medley’s opportunity, stable to rising yields, consistent volume at consistent risk profile and size versus larger market with the opposite, arguably lighter risk and lower yield, the relative value at a constant risk of the yield we produce is rising. So I think we feel very good about the opportunity, we feel very good about the origination and it’s really becoming a really attractive relative market opportunity in the credit and the overall fixed income space.

Mickey M. Schleien – Ladenburg Thalmann & Co., Inc.

And Brook did you say that the deal flow was roughly split between sponsored and non-sponsored, I didn’t quite catch that?

Brook Taube

I don’t have the split for you Mickey, but it’s balanced and we have volume from both.

Mickey M. Schleien – Ladenburg Thalmann & Co., Inc.

All right fair enough. Thanks for your time.

Operator

Your next question comes from the line of John Heck from Stevens. Please proceed.

John Heck – Stevens Investment Bank

Good morning guys thanks a lot for taking my questions. First one, can you give us a sense for the timing of deployment in the last reported or this reported quarter?

Brook Taube

I don’t have that number, sorry John.

John Heck – Stevens Investment Bank

Then do you have any – just thinking about the quarter, did it seem front-end, back-end of balanced in your perspective or you just – it’s not even worth commenting if you don’t have anything in front of you?

Brook Taube

I just don’t want to comment, it wasn’t our naturally weighted one way or the other versus prior quarters, but I don’t have the numbers in front of me.

John Heck – Stevens Investment Bank

Okay. And then Jonathan asked some questions about fee income earlier that you addressed, but I’m wondering just if we could ask in a different way, if repayment activity was normal and I don’t even know necessarily what that means given to traject the trends we’ve seen in the last few quarters, but in a normal environment of repayment activity, do you have a sense what a good base level of fee income would be just from a modeling perspective?

Brook Taube

It really will depend, I don’t want to answer that question specifically, I think you can make a judgment. We typically have a window of no call and then we have prepayments that come down through time. So it could be 3, 2, 1, no call 1, 3, 2, 1; you would have to pick the deals of prepaid and you would have to have a real crystal ball like to sort of come up with a number specifically. I think your assumptions going forward would likely be as good as ours or your judgment on that.

John Heck – Stevens Investment Bank

Yes, fair enough I got you. And then you commented that this quarter saw the first uptick in pricing relative to last few quarters. And if I look at your pipeline, it looks like that, that trend is persisting and you talked about the market trends I mean, your commentary was optimistic. Do you think you guys are a little bit potentially than outlier given your source of originations and you are a little bit more proprietary at feeding mystery [ph] or do you think this is more of an industry trend where maybe the pricing in the middle markets is getting more favorable to the group of lenders?

Brook Taube

Well, I think the comment of our overall volume, we just track every deal that comes in, and I would just – made the reference to stable to up which is different from the prior quarters’ trends. It’s hard to know what drives that, but I think the notion that there is not as much capital and that maybe the kind of risk off ideas, there it maybe the case and maybe that we rolled in to the New Year, we’ll keep an eye on it and keep you posted.

Our market opportunity remains attractive. What we’re just seeing on a secular trend, as you can see, is the players they were otherwise here and departed years ago or grow even larger. So the competitive threat from end-market players that are bigger has not emerged, that’s not to say they may not come back down market, but we are seeing them consistently go up market. There have been obviously some people enter, but you haven’t seen the new entrance focused on what we do.

So that’s more of an overall comment. With respect to the direct origination, look there is – we now have 50 people, we’ve done this for – this our twelfth year as a team, there is value in going direct. We’ve talked about this on calls previously, the returns are higher, the structures we on balance think are better and the performance, it’s not – it’s certainly not riskier, that may actually be safer. So if you do the hard work and you have the funnel, there is an attractive risk of adjusted return. So I do think there is value especially in this market. Does that answer the question?

John Heck – Stevens Investment Bank

That does very much, thanks very much guys.

Brook Taube

Thanks John.

Operator

Your next question comes from the line of Casey Alexander from Gilford Securities. Please proceed.

Casey J. Alexander – Gilford Securities, Inc.

Good morning. And that actually leads into my question, which is looking at your backlog it almost appears as though you are pushing a little up market and I see a $45 million piece there. Now are you planning on taking partners to sort of right-size that or splitting some between your co-investment opportunity. And when you get into deals of that size, are you seeing a different competitive element?

Brook Taube

Yes, I think as we’ve always said on both the sponsored deals that we look at, there is generally more competition in lower pricing. It’s not bad or good, it just is what it is. On the larger deals, they tend to be more competitive that’s there in that always. We have the ability to take all of the $45 million deal at Medley now. I would expect that we would not put $45 million unto the balance sheet of MCC today.

So there is two things we would do on a larger deal. We would either split it which we have the ability to do or in some instances and it’s a topic just by way of example on one of our deals in the pipe. We are specially reaching out to a group that is in our business and also has expertise on the equity side, in the industry specifically of this opportunity, and their friends and they will come in and we’ll effectively add them to the deal. That would be both a risk mitigation, risk size issue for us as well as inviting in people we know extremely well that have much – have better and deeper knowledge in the industry specifically. Does that answer it?

Casey J. Alexander – Gilford Securities, Inc.

I think the answer to every question was yes. So yes, but that definitely answered it, thank you.

Brook Taube

Thanks Casey.

Operator

Your next question comes from the line of Patrick Buckley from UBS. Please proceed.

Patrick D. Buckley – UBS Securities, LLC

Good morning guys and thanks for your call. I wanted to again talk about your comment on pricing stable to rising yields. As you have shifted from an increasingly floating rate exposure, you’ve gone from the low 40s earlier last year to up to 60% this year. Has that affected any of the yields that you’ve seen in your new originations. I just wanted to see if you could talk about that, thank you.

Brook Taube

Yes, I think we can foreshadow that if you are in a positively sloped yield curve, and this one is very on the front-end. There is a give up by being floating versus fixed, I mean that’s generally speaking that is the case. So for example, on a deal that yielded 11 floating LIBOR plus a spread that was floating, to make it a fixed rate you would earn higher with yields apples-to-apples. So there has been in hindsight clearly a modest cost being floating.

And as we’ve said that shift we were going to do overtime, we’ve been measured, it’s been the right decision. If you rewind three years, we told folks it was appropriate to be fixed, we saw deflation, we saw challenges that’s starting to shift. We’re not calling the economy, but we’re migrating towards more floating rate assets as the risk reward on the front-end, we believe it’s favoring rising rates at some point. So yes, it does, there was a slight cost, which is what we otherwise could have done, but our judgment on a risk adjusted basis was that that was the right move.

Patrick D. Buckley – UBS Securities, LLC

Great, that’s what I thought. Thank you.

Brook Taube

Okay, great.

Operator

Your next question comes from the line of Jonathan Bock from Wells Fargo Securities. Please proceed.

Jonathan G. Bock – Wells Fargo Securities, LLC

Just a quick follow-up Brook, as it relates to the origination composition just this past quarter, first and second lien. But, broadly speaking it would appear that some of the second liens maybe carry a slightly higher dollar amount relative to maybe some of the first liens where the first liens are larger in number. So your mix is still there. I’m just curious, is there a reason that once taking maybe a larger portion in terms of chunkiness in size in that second lien category as opposed to the first. Maybe just a little color on that mix and breakout, and where you see attractive risk adjusted returns first versus second.

Brook Taube

Sure, I don’t – there was no a prior [ph] decision, I wouldn’t read anything into it, but just the quarter and the volume and the way that deals came in.

Jonathan G. Bock – Wells Fargo Securities, LLC

Okay, that’s great. Thank you.

Brook Taube

Thanks Jonathan.

Operator

This concludes our question-and-answer session. I will now turn the call back to Mr. Brook Taube.

Brook Taube

Well, thank you all for the continued support. We are looking forward to a very successful 2014 and as always we’re available here at the office if you would like to follow-up. So thanks again, and we look forward to speaking to you on the next call.

Operator

This concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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