THL Credit's (TCRD) James Hunt on Q1 2014 - Earnings Call Transcript

| About: THL Credit (TCRD)

THL Credit, Inc. (NASDAQ:TCRD)

Q1 2014 Earnings Conference Call

May 13, 2014 08:30 AM ET


Stephanie Paré Sullivan – General Counsel and Chief Compliance Officer

James K. Hunt – Chairman and Chief Executive Officer

Terrence W. Olson – Chief Operating Officer and Chief Financial Officer


Lee Cooperman – Omega Advisors, Inc.

Jonathan Bock - Wells Fargo Securities, LLC

Derek Hewett - Merrill Lynch

Vernon C. Plack - BB&T Capital Markets


Good morning, and welcome to the THL Credit’s Earnings Conference Call for its First Fiscal Quarter of 2014. It is my pleasure to turn the call over to Ms. Stephanie Sullivan, Chief Legal Officer and General Counsel of THL Credit. Ms. Sullivan, you may begin.

Stephanie Paré Sullivan

Thank you, operator. Good morning and thank you for joining us. With me today are Jim Hunt, our Chief Executive Officer; and Terry Olson, our Chief Operating Officer and Chief Financial Officer.

Before we begin, please note that statements made on this call may constitute forward-looking statements within the meaning of the Securities Act of 1933 as amended. Such statements reflect various assumptions by THL Credit concerning anticipated results, are not guarantees of future performance and are subject to known and unknown uncertainties and other factors that could cause actual results to differ materially from such statements.

The uncertainties and other factors are, in some ways, beyond management’s control, including the factors described from time-to-time in our filings with the Securities and Exchange Commission.

Although we believe that the assumptions on which any forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also to be incorrect. You should not place undue reliance on these forward-looking statements.

THL Credit undertakes no duty to update any forward-looking statements made herein. All forward-looking statements speak only as of the date of this call. A web cast replay of this call will be available until May 20, 2014, starting approximately two hours after we conclude this morning. To access the replay, please visit our website at

With that, I’ll turn the call over to Jim.

James K. Hunt

Thank you, Stephanie. Good morning. Thank you for joining this morning’s call covering the results of THL Credit’s first fiscal quarter of 2014. Our earnings announcement and 10-Q were released yesterday afternoon, copies of which can be found on our website along with the Q1 Investor Presentation that we will refer to during this call.

This morning, we will provide an overview of THL Credit’s investment activities as well as financial highlights for the first fiscal quarter of 2014. I will also offer our views on how we will continue to grow our portfolio and drive shareholder returns in the current middle market investment environment.

We completed the first quarter with 58 portfolio companies valued at $739 million after investing $128 million during the quarter in seven new transactions; and five follow-on investments in existing portfolio companies. Realizations and repayments were $36 million.

Our five offices remain focused on developing and furthering key relationships with private equity firms and sponsors, financial advisors, banks and other lending partners consistent with direct origination of investments, which has been a hallmark of our sourcing success. As such, approximately 88% of our investments in Q1 were directly originated.

Over the last four quarters, we have averaged $78 million in net portfolio growth for each quarter, which was comprised of new investment activity, averaging $120 million in realization through prepayments and sales averaging $42 million.

With an increasingly competitive middle market landscape, characterized by tightening spreads and increasing leverage levels, we have continued to focus on finding the most attractive risk-adjusted investment opportunities, which should have generally been higher in the capital structure.

Throughout 2013; and into 2014, we have increased the amount invested in first lien and second lien securities which now account for 72% of our overall portfolio on a fair value basis. And in the face of inevitable rising interest rates, we’ve tended to emphasize more floating-rate securities. You can see this on Page 13 of our investor presentation, which shows 67% in floating rate investment as of March 31, 2014, up from 45% from March 31, 2013.

The overall credit quality of our portfolio continues to remain strong, 85% of the companies in our portfolio on a fair value basis, received either a one or two credit score, which means that they are meeting or exceeding our underwriting expectation.

We continue to have two investments on non-accrual with a credit score of 4 and move to third investment Wingspan to non-accrual during the quarter. Wingspan was also moved to a credit score of 5 in connection with the reversal of $1.4 million accrued in uncollected interest income previously booked in 2013.

As of March 31, 2014 the three loans on non-accrual status had an amortized cost basis of $39 million or 5.3% of the portfolio. As with any underperforming investments, we’ve increased the level of supervision of their performance and liquidity, we are continuing to work with the sponsors, company management and our advisors to accomplish successful realization.

In terms of liquidity, we are pleased with the $85 million expansion of our credit facility on April 30 to $410 million from $325 million, with reduced pricing and extension of maturity dates. Pricing on our revolver decreased from LIBOR 300 to LIBOR 250; and pricing on the $106.5 million term loan decreased from LIBOR 400 to LIBOR 325. The additional liquidity and the lower cost of capital will continue to grow the returns to our shareholders.

As of March 31, 2014; we had $305 million outstanding on our credit facility, representing 0.67 of our net asset value. As we have noted on our prior calls, we are comfortable with maintaining debt-to-equity levels in the 0.50 to 0.75 range.

Given the increasing compensation of the portfolio in more secured loans, we are comfortable at the higher end of this range. As you can see on Page 18 of the Q1 Investor Presentation, we have approximately $169 million of liquidity between our undrawn revolver and cash balances as of yesterday.

Pages 10 and 11 in our Q1 Investor Presentation highlight our growth to-date. While our pipeline remains strong, and we continue to deploy capital and attractive investment opportunities, our net growth from quarter-to-quarter can fluctuate based on origination and realization. We have highlighted this on Page 11 of the Investor Presentation. While we have seen an increase in the prepayment level in the second quarter, our pipeline remains active.

Now, moving into our financial highlights. Net assets as of March 31 were $452 million or $13.34 per share compared with $13.36 per share on December 31. Our net investment income for the first quarter totaled $10.7 million or $0.32 per share. And Terry will speak more about the components of the earnings in a few minutes.

In Q1 2014, we paid a dividend of $0.34 per share as compared to a net investment income of $0.32 per share. Consistent with our past practice, we intend to pay dividends that are in line with earnings, which as you know, can be lumpy. As I previously mentioned, we see the most attractive investment opportunities at the higher end of the capital structure. These lower yielding securities have put some downward pressure on our overall weighted average yield.

However, based on other key drivers impacting earnings, including investment activity to date in Q2, and our current pipeline, as well as the use of our credit capacity at lower cost of capital, we expect net investment income to support our current dividends. We are pleased to announce that on May 7, our Board of Directors approved a quarterly dividend of $0.34 per share for the first fiscal quarter 2014, that is payable on June 30.

With that, I’ll turn the call over to Terry to talk more about the investment activity and greater detail in our financial performance.

Terrence W. Olson

Thanks, Jim, and good morning, everyone. I wanted to start by describing our seven new investment transactions this quarter, and provide you with a little color on each.

First, we made a $24.9 million investment in the senior secured term loan of Igloo Products Corp., a designer, manufacturer and marketer of ice chests and coolers. Igloo is headquartered in Katy, Texas.

Next, we had a $20.0 million investment in the second lien term loan of TriMark USA, food services equipment and supplies distributor. The company is headquartered in South Attleboro, Massachusetts. We made a $12.0 million investment in the second lien term loan of Tectum Holdings, supplier of truck bed covers and bed liners. The company is headquartered in Ann Arbor, Michigan.

We also made an $11.0 million investment in the second lien term loan of Synarc-Biocore Holdings, a provider of specialized services to the pharmaceutical industries, the company is headquartered in Newton, Pennsylvania. We made a $10.3 million investment in the senior secured term loan and a $800,000 equity investment in Allied Wireline Services, an independent wireline service provider to the energy industry. Allied is headquartered in Houston.

We made an $8.3 million investment in the senior secured term loan of BeneSys, Inc., a provider of technology enabled third-party administrative services to multi-employer trusts, this company is headquartered in Troy, Michigan.

And finally, we made a $9.9 million commitment to the senior secured term loan of Wheels Up Partner; of which $5.4 million was funded during the quarter, along with the $1 million equity investment. Wheels Up provides membership-based private aviation for individuals and corporations and is headquartered in New York.

If you refer the Pages 13 through 15; as well Pages 20 through 24 of the Investor Presentation, you’ll see the details on our portfolio investment, specifically their composition, credit profile and yields. The weighted average yield on all investments made in Q1 was 10.6%.

The weighted average yield on all of our income producing investments as of March 31 was 11% and 10.7% for our debt-only securities. You’ll see we provided additional details on page 15 of our Investor Presentation on the breakdown of yields over time.

Notable sales and repayments for the quarter included the following. $16.8 million in proceeds and the repayments of our debt investments in SeaStar Solutions, which included a prepayment of $300,000, $8.4 million from the full repayment of our remaining investment in LCP Capital, $4.9 million for the partial sale of our debt investment in Surgery Center Holdings, $1.5 million in proceeds from the repayment of our revolving facility in Key Brand Entertainment, and 900,000 from the sale of our equity investment in Jefferson Management Holdings.

As of March 31, the portfolio at fair value was invested 45% in first lien debt including unitranche structures, 27% in second lien debt, 20% in subordinated loans, 7% in income-producing investments, which include CLO residual interest and 1% in equity securities.

Before discussing Q – for the income statement in Q1, I would like to highlight some notable portfolio activity since March 31. We received proceeds of $52 million from the repayment or sale of our investments in MCM, Blue Coat and Cydcor. The MCM repayment results in a $1.3 million prepayment premium and the acceleration of unamortized discounts of approximately $1 million.

From our portfolio this quarter we derived $20.9 million in investment income during the quarter, of which $15.9 million was from interest income on debt securities, which included $500,000 for pick interest and $300,000 of prepayment premiums. Our Income also included $1.7 million from interest income on other income producing securities and $2.1 million of dividend income from our equity investments in YP and Surgery.

Other income was approximately $1.2 million included $800,000 of fee income from our managed funds and $400,000 was related primarily to amendment and other administrative fees earned from our investments. Increases in the investment income compared to the same periods of prior years is primarily due to the growth of our investment portfolio, the dividend income from our equity investments and fees related to the managed funds.

During the quarter, we incurred $10.2 million of expenses including $2.7 million of incentive fees, $2.5 million of base management fees, $2 million in general and administrative and professional fees and $2.4 million in fees and expenses related to our credit facility.

In addition, we recorded an income tax provision related to our dividends and earning on our equity investments held by consolidated blocker corporations of $500,000 and excise taxes of $100,000 related to undistributed earnings.

Net investment income for the quarter totaled $10.7 million or $0.32 per share, compared to the dividend paid in March of $0.34 per share. Notable drivers to our earnings were the $92 million of net new investments, of which approximately 70% of the new investments during the quarter closed during March.

Secondly, $2.1 million of dividend income on our equity. These earnings drivers were primarily offset by the reversal of previously accrued interest of $1.4 million as Jim mentioned earlier.

Prepayment premiums of $300,000 during the quarter were smaller, compared to previous quarters and there was significant acceleration of unamortized discounts, which rather notable reasons for lower net investment income during the quarter. During the quarter, we recognized net realized gains of $299,000 related primarily to a gain of $754,000 from our equity distributions from surgery offset by a realized loss of $456,000 recognized from sale of our equity holdings in Jefferson Management.

In addition, we recognized a current tax provision related to realized gains in connection with the revised 2013 tax estimate of $321,000. Furthermore, the net decrease in unrealized depreciation investments of $609,000 during the quarter was driven by changes in capital market conditions and the financial performance in certain portfolio of companies and the reversal of net unrealized depreciation on investments repaid or sold.

During the quarter, we also recognized the tax benefit on unrealized gains of investments of $971,000 related to our consolidated blocker corporation subsidiaries. The decrease in the provision for tax on unrealized gains related primarily to change in the unrealized appreciation from the investments held in these subsidiaries. For interest rate derivative, we realized a net loss of $113,000 in the quarter as a result of the amounts paid under the interest rate swap and had a positive change in the unrealized depreciation of $54,000, which is a result of the changes in the swap rate.

And with that, I’ll turn the call back over to Jim.

James K. Hunt

Thanks, Terry. I’d like to close our formal remarks with a quick summary. We are pleased with our investment pace and the investment pipeline of directly originated by our five offices, as well as the nearly $92 million of net growth in the portfolio this past quarter. The overall credit quality of our portfolio remained strong, and we are actively supervising any underperforming investments. Lastly, the recent expansion of our credit facility at a lower cost and extended tenure provides us with the liquidity necessary to fund the near term growth of our portfolio.

I would now like to open the lines or questions, operator.

Question-and-Answer Session


Thank you. (Operator Instructions) Our first question comes from Lee Cooperman with Omega Advisors. Your line is open.

Lee Cooperman – Omega Advisors, Inc.

Yes. Thank you. I appreciate the rundown. I’m curious, looking at your budgets and your strategy, would you think that the distribution will end the year higher than it’s running now or you think that any incremental distribution behind the through special.

James K. Hunt

Well, Lee, thanks for joining today. And on that question, I think the special dividends – the special dividends in the past have been related to what we have felt were one time gain. And rather than build an expectation into our base dividend, we’ve handled those as special dividends which I think our constituents have supported that that approach.

Lee, I think the question for the balance of the year is going to depend on, one we intend to maintain leverage at a higher level. I think in the last month, we’ve seen spreads move to be one click more favorable.

So I think it’s going to be a question on, are there suitable more junior capital investments at a higher spread level, and what is the pace of prepayment activity that in the past we’ve – the base dividend has benefited somewhat significantly from the pace of prepayment activity. So I think it’s a – I think that goes beyond our crystal ball. But I think those are really the drivers responding to your question.

Lee Cooperman – Omega Advisors, Inc.

I assume the only time we will rise as you levered a bit more right

James K. Hunt

Absolutely. And this is notably, the highest leverage level we have achieved in – we have been very – we’ve really let the left hand side of the balance sheet pull the right hand side. So we’ve not issued equity since last September and have really chosen to add leverage and drive EPS through that incremental leverage and not diluting with follow on share issuance.

Lee Cooperman – Omega Advisors, Inc.

Yeah. I would hope that policy will continue, not like to see issuance of equity below NAV. This is a personal view.

James K. Hunt

We can only lose your confidence once.

Lee Cooperman – Omega Advisors, Inc.

You got it. Thank you. Good luck. Thank you for the report.


(Operator Instructions) Our next question comes from Jon Bock with Wells Fargo Securities. Your line is open.

Jonathan Bock – Wells Fargo Securities, LLC

Good morning and thank you for taking my questions. So, Jim, real quick, more of a scenario analysis, but in light of BDC stock price pressures pushing the number of names below NAV or let’s say below a threshold that shareholders would find prudent to be issuing equity whether one was fully levered or not.

Can you walk us through the dividend paying ability in the event that equity issuance likely does not occur, leverage remains high and we’re more of in a churn situation than we are in a stable net portfolio growth situation? Could you may be walk through that scenario and what PCRD investor should expect in the event that, that comes to pass over the next several months?

James K. Hunt

You know that – I think that’s a fascinating question and I think that our guiding philosophy has been prudence and patience. And that there is a possibility that the market overall will go through a slower asset growth period as the economies in the slow growth period.

If you look at BDC yields broadly relative to capital market levels, it’s at a very high spread relative to high yield indices, which could be technical, could be a question about somewhat compressed spreads, but those spreads are still at a historically very high level, but where we would not hesitate to sit on the sidelines in growing the portfolio if we didn’t see attractive risk adjusted return investments.

So, certainly, it would be interesting to see where BDCs trade post the Russell rebalancing – perhaps the market reflecting on the yields at which BDC is broadly are available relative to other higher yielding choices. But, we for one, feel like that $169 million of liquidity that I addressed relative to what changes turn over there will be our portfolio were comfortable that we can comfortably manage your pipeline.

Jonathan Bock – Wells Fargo Securities, LLC

And then may be a question as it relates to exposure to second lien, and this is always a question because at sometimes the term second lien similar to mess, sometimes elicits a negative response. And again we understand that not all credits are created equal, but as we look at Tectum, TriMark, or Synarc-Biocore, the question is those are second lien transactions part of a let’s say $100 million tranche or so of which TCRD participated between 20% and 10%.

Can you give us a sense of any potential frothiness in those securities? The reason we asked the question is, we found that those deals that are typically more marketed tend to have poor credit characteristics and we would appreciate maybe your thought process as you look at those investments from an underwriting perspective given that they carry that second lien name.

James K. Hunt

Here is what it’s interesting about it is, I don’t disagree with your characterization broadly, but one of the things is, in several of the investments you mentioned were brought to us because of the special relationship either with the sponsor or the senior lender. We had a special seat at the table. And as I think you’ve seen before, we’re binomial on credit. It’s got to be a good enough credit.

So while they appear to have more of a marketed style, the reality was it was much more of a club in its execution and at the end of the day, the credit metrics starting with fixed charge coverage most importantly to us, we’re very consistent with the return we want for that level of risk.

Jonathan Bock – Wells Fargo Securities, LLC

Okay. And then as we look at repayment activity and I think, Terry, you mentioned this is just one thing I wanted to catch as it relates to NCM I think you mentioned the $1.3 million prepayment fee, but then just to make sure I got you correct, there was a also an additional million dollars that will come in the form of amortized fees, is correct?

Terrence W. Olson

[For us the] (ph) basically the GAAP gone at this point between the cost basis you’ll seen in queue in the par. So...

Jonathan Bock – Wells Fargo Securities, LLC

Okay. Thank you so much.

James K. Hunt

Thank you.


(Operator Instructions) Our next question comes from Ken Bruce with Bank of America. Your line is open.

Derek Hewett – Merrill Lynch

Good morning, Derek Hewitt for Ken Bruce this morning. Quickly, I have a follow-up question regarding the pipeline, given that exits are trending a little bit higher subsequent to quarter end, could you talk about the kind of your outlook for the pipeline?

James K. Hunt

Well, it’s interesting on the pipeline. It has been of late – it’s been more sponsored at transactions than unsponsored. I think the level of – the quality of the seat we have at the table has continued to get better, so the actionability of investments has gotten better. I think the realizations for the second quarter are by-and-large behind this.

So I would be hopeful that we have net growth for the balance of the quarter and the – I would say that would be perhaps led by the more traded credit marketplace, where spreads have picked up in the last month approximately five weeks that is probably creating a positive environment for the lender markets where we’re a lender not a buyer, I think it has positive implications for the lender market.

Cyclically, we are getting to the time of the year, where middle market companies start changing hand, so we should be entering into the more favorable season to be making investments. So cyclically, our pipeline should be becoming larger and more active for the balance of the year.

Derek Hewett – Merrill Lynch

Okay, great. And then could you talk a little bit about the amount of undistributed earnings that you guys currently have?

Terrence W. Olson

Sure. We have approximately $3.3 million of undistributed NII, almost $0.10 a share at this point.

Derek Hewett – Merrill Lynch

Okay, great. Thank you very much.


Our next question comes from Vernon Plack with BB&T Financial. Your line is open.

Vernon C. Plack – BB&T Capital Markets

Thanks. Jim, question on the CLO equity portion, I know that that’s going to place where some folks have thought some yield and just curious in terms of your current thinking on opportunities with CLO equity and those residual types of opportunities?

James K. Hunt

Well, as we mentioned before, we think it’s – when that market is cheap and we know the underlying credits, we know the manager well, and we leverage our own traded credit team heavily to I think make better investments there. Our approach has been to have also I should note less than 25% of the equity in those transaction.

At the point in time we made those five investments, we thought the arbitrage was compelling. And it might be worth Terry adding a sidebar on our accounting approach to those investments, I would say of late the arbitrage has improved, but it would take so not only is the arbitrage in the last month returned to be more favorable, we do have a limited amount of capital we want to commit to those investments. Two, it would take having confidence in the manager and feeling very comfortable is the underlying asset choices.

So, I would say, if possible we will make another – an investment or two, but not significantly beyond that. But Terry you just wanted to talk about the accounting approach in terms of amortizing the basis down?

Terrence W. Olson

Yeah, as folks may or may not know we’re using an effective yield method which we are basically recognizing income based on an expected return profile over the life that we hold the vehicle, which is consistent with what most folks are doing in the market obviously and we think the best approach under GAAP.

Yeah, you could see some of that, that income or return expectation decreasing a bit, but there is a lot variables, I know Vernon, as you can appreciate, some of which are tidy yield, and some of which are archived more quite frankly to just, general default levels, recovery levels et cetera. So, a lot – a myriad of factors go into it, but that’s the approach that we’ve taken in the past with the income recognition there.

Vernon C. Plack – BB&T Capital Markets

Okay. Can we expect anything different out of you in the upcoming quarters? Are you looking at anything outside of the traditional types of investments that you have been making? Are you looking at anything that will fall to the 30% bucket?

Terrence W. Olson

Well, within the 30% bucket, we do have it and one of our senior investment leaders specializes in financing of especially financed businesses.

Vernon C. Plack – BB&T Capital Markets


Terrence W. Olson

And so those would fall in the 30% category, they are – again, they were a lender not a buyer, they’re well underwritten by somebody’s got this is Monty Cook, that I am referring to. He’s got tremendous experience in this space. So those would be, I consistent in style with middle market, higher yielding junior capital investments, but would be in that category. But beyond that, we are not contemplating anything such as an operating company or something of that – that’s what you’re referring to, Vernon.

Vernon C. Plack – BB&T Capital Markets

Okay. That’s helpful. Thank you.


And I’m showing no further questions. I will now turn the call back over to Jim Hunt for closing remarks.

James K. Hunt

Well, thank you, operator, and thank you to all of you for joining us today. We look forward to seeing you in early August. Take care.


Ladies and gentlemen, that does conclude today’s conference. You may all disconnect. Everyone have a great day.

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