American Capital Senior Floating Ltd (NASDAQ:ACSF)
Q2 2014 Results Earnings Conference Call
August 05, 2014, 9:00 am ET
Mark Pelletier - President and Chief Investment Officer
Dana Dratch - Senior Vice President, Portfolio Manager and Head of Trading
Mike Cerullo - Senior Vice President, Portfolio Manager and Head of Research
John Erickson - Chief Financial Officer and Executive Vice President
Greg Mason - KBW
Chris Kotowski - Oppenheimer & Company
Good morning, and welcome to the American Capital Senior Floating second quarter 2014 shareholder call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note, this event is being recorded.
Now I would like to turn the conference over to Erin Krohne [ph] Investor Relations. Ms Krohne, please go ahead.
Unidentified Company Representative
Thank you, Keith. Thank you, all, for joining American Capital Senior Floating's second quarter 2014 earnings call.
Before we begin the call, I would like to review the Safe Harbor statement. This conference call and corresponding slide presentation contains statements that, to the extent that they are not recitations of historical fact, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of ACSF. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.
Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the Risk Factors section of ACSF's periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at www.sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law.
An archive of this presentation will be available on our website, and the telephone recording can be accessed through August 18 by dialing 877-344-7529 or 412-317-0088 and the conference ID number is 10049314. To view the slide presentation turn to our website, acsf.com and click on the Q2 2014 Earnings Presentation link in the upper right- corner. Select the webcast option for both slides and audio or click on the link in the Conference Call section to view the streaming slide presentation during the call.
Participants on the call include Malon Wilkus, Chairman and Chief Executive Officer, John Erickson, Director, Chief Financial Officer and Executive Vice President, Mark Pelletier, President and Chief Investment Officer, Dana Dratch, Senior Vice President, Portfolio Manager and Head of Trading, Mike Cerullo, Senior Vice President, Portfolio Manager and Head of Research, Christina Houghton, Vice President and Controller.
With that, I will turn the call over to Mark Pelletier.
Thanks, Erin, and thank you, all, for participating on today's call. Before I review our second quarter earnings, I would quickly cover our business structure and overall objective.
ACSF is a BDC that invests primarily in senior secured first and second lien floating rate loans to large market companies and seeks to enhance returns by opportunistically investing in collateralized loan obligations for CLOs collateralized by senior secured floating rate loans. We feel we have a compelling fee structure for the management fee of 80 basis points on assets and no incentive fee. We believe our management style, asset selection and our shareholder friendly fee structure uniquely positions ACSF as a senior floating BDC and should allow us to achieve our investment objective of providing attractive, risk-adjusted returns to our shareholders over the long-term.
Overall Q2 was a strong quarter for ACSF and we are pleased with the performance of our portfolio. As reminder, this was our first full quarter following our IPO. At a high level, NAV was essentially flat, our portfolio grew slightly and the mix shifted modestly as we added a couple of more CLO positions. Credit quality remains stable and while our yields were down somewhat, our net investment income was a respectable $0.29 a share, allowing us to declare and pay a dividend of $0.28 this quarter.
With that, let's us move to slide four to review the highlights for the quarter in a bit more detail. As of June 30, ACSF had an investment portfolio of $287 million comprised of $204 million in senior secured first lien floating rate loans, $35 million in senior secured second lien floating rate loans and $48 million invested in CLOs. The weighted average yield as of June 30 on the portfolio was 6.33%, which is slightly below the March 31 yield of 6.39%, due primarily to declines in the projected yields on our CLO portfolio, which I will discuss in more detail shortly.
Our debt to equity ratio was 0.85 to 1. NAV for the quarter was $151 million or $15.12 per share, up $0.01 from last quarter. Net investment income for the quarter was $2.9 million or $0.29 per share. We had a net earnings of $2.8 million or $0.28 per share this quarter. Our Board of Directors declared a dividend of $0.28 per share for Q2, which was paid on July 10. Our estimated undistributed taxable income at the end of the quarter was $1.4 million or $0.14 per share, which remained unchanged from the last quarter.
Now let me turn the call over to Dana Dratch, Senior Vice President, Portfolio Manager and Head of Trading to quickly review slide five and six, which are an overview of the leveraged loan market.
Thank you, Mark. Turning to slide five, you can see that the market for leveraged loans remained very large at more than $758 billion outstanding as of June 30. Within the leveraged loan market, almost 99% of the loans are considered large market loans and of those 95% are first lien loans. Large market loans are defined as companies with EBITDA that is greater than $50 million.
On slide six, you can see that the leveraged loan market continues to be healthy and active. The chart on the left shows a slight drop in new issue volumes for the LTM period ending in the second quarter. However, a majority of that decline was driven by a drop in refinancing and repricing activity. In fact, traditional new money institutional loan volume, which is comprised mainly of acquisitions, leveraged buyouts and dividend recapitalizations was essentially flat for the quarter at $53.6 billion, compared to $64.6 billion for the first quarter of 2014. While CLO volumes over the course of the quarter were very strong with $38 billion of issuance, retail funds experienced an $8 billion outflow. We believe that this outflow helped drive the slowdown in refinancing and repricing activity and yields on new issues widened largely in response to those factors.
The chart on the right shows defaults for the second quarter. The majority of the increase in the default percentage, which is highlighted in grey in the chart, was attributable to the April default of TXU which was a 2007 transaction that had been expected to default for some time. I want to point out that this asset not in ACSF portfolio. Excluding this one large legacy default, you will see that defaults remained relatively benign at 1.1% in near historic lows.
Overall secondary trading activity was robust for the quarter. According to data from the Loan Syndications and Trading Association, second quarter trading volume rose to $170 billion, which was a record, while trailing 12 month secondary volume of $552 billion was also record, pointed to strong market liquidity.
Now I will turn the call back over to Mark to discuss our portfolio.
Thanks, Dana. Turning to slide seven, you can see the chart in the left that we have, a $287 million portfolio comprised of $204 million or 71% of the portfolio in first lien loans, $35 million or 12% in second lien loans and $48 million or 17% in CLO equity. As we mentioned on the first quarter earnings call, we rebalanced the portfolio modestly during the quarter with a 4% increase in CLO equity and a commensurate decrease in first lien loans.
The chart on the right shows the yield at cost for the total portfolio of 6.33% as of June 30 for the 5.28% weighted average yield on the leveraged loans and a 11.57% yield on CLO equity. The entire portfolio was diversified across 121 individual issuers with an average position concentration of 0.8% and a maximum of 1.9% per issuer. Overall, we feel very good about the mix of the portfolio.
Turning to slide eight, we take a closer look at the loan portfolio. Our loan portfolio is valued at $240 million and is invested across the 108 portfolio companies with a weighted average yield of 5.28%. The weighted average cost of our loan portfolio stands at approximately par. Our entire loan portfolio was comprised of floating rate loans, with 99% of these loans having LIBOR floors at a weighted average LIBOR floor of 104 basis points. We have a diverse mix of companies and industries and importantly we continue to acquire our portfolio essentially at par, thereby reducing certain risks associated with refinancing activity.
Now I would like to turn the call over Michael Cerullo, Senior Vice President, Portfolio Manager and Head of Research to discuss the credit quality of the portfolio.
Thanks, Mark. On slide nine, we have presented an overview of the credit quality of our loan portfolio. We haven't seen any major changes in credit quality over the course of the quarter. We continually monitor the portfolio in order to be aware of any changes that could impact credit quality. In addition to daily monitoring, we thoroughly review each investment on a quarterly basis, including the investments, industry environment, any changes that have occurred in recent months.
This allows us the opportunity to not only review the investment thesis for each name, but to also look at industry and portfolio trends overall and the relative value of investments across the portfolio. Fundamentally, we analyze the credit worthiness of our companies with an emphasis on cash flows and overall capital. As of Q2, none of our investments were on non-accrual and 80% of our loan portfolio had a facility credit rating by S&P of at least B or higher.
Before I turn the call back over to Mark, I want to give you some context around the types of companies we are investing in. When you look through to our underlying portfolio of companies and look at some of their financial metrics, you get a sense beyond just a rating for the size of the companies we are invested in. Across the 108 portfolio of companies in our loan portfolio, the median revenue is $600 million and the median adjusted EBITDA is in excess of $130 million.
As Mark and Dana have discussed in the past, our borrowers are mostly what we call large market companies, which we define as companies with EBITDA of $50 million or more. Our strategy of investing in these types of loans allows us to pursue investment opportunities for a larger and more liquid market without turning to the middle market creating greater opportunities for diversification of our portfolio additionally.
Now I will turn the call back over to Mark to discuss the CLO portfolio.
Thanks, Mike. Turning to slide 10. During the second quarter, we added three CLO investments to our portfolio, bringing our total CLO investments to 13 with $48 million in value as of June 30. The new CLOs that were added to the portfolio during the quarter had an accounting yield of just over 12%. Overall the accounting yield in our CLO portfolio is nearly 11.6% as of June 30, which is down from 13.9% as of March 31. In addition to the impact of the new CLOs added during the quarter, the primary drivers of this declining yield are driven by spread and credit assumptions used in the modeling of projected cash flows.
If you recall, in accordance with GAAP, we use the effective yield method to recognize income on our CLO portfolio. GAAP requires us to forecast the projected cash flows each quarter to calculate the effective yield on a prospective basis. We use these same projected cash flows in our quarterly valuations. These projected cash flows are derived using observable market assumptions including constant default and recovery rates. Generally these assumptions apply expectations based on historical overall long-term market experience and do not give credit to an individual CLO managers past outperformance based on asset selection skills or trading abilities which we emphasize our CLO equity selection process.
With that said, I will take a deeper dive into the two primary assumptions, portfolio credit and reinvestment spread. Currently for accounting purposes we apply a constant default rate of approximately 2% annually for the portfolio in each CLO structure. In reality credit defaults tend to come in waves. And today the credit environment is relatively benign with industry defaults running well below this figure. To the extent that the default experience is below the constant default rate, then the actual cash flows produced by the CLO should exceed our current projections. Obviously, there can be scenarios were CLO cash flows are less than projected.
The approach we employ for reinvestment spread assumptions in our projected cash flows is to take the most recently reported portfolio spread and assume that same level of spread going forward. Using this flat spread assumptions for the rain remaining expected life of the CLO does not take into consideration a manager's ability to actively trade the portfolio to increase spread. Generally spreads or loans issued in the primary market have tightened since the second quarter of 2013 and as a result, the project the cash flows for CLO investments have come down.
To the extent that managers of our CLO investments can reinvest at higher spreads and currently assume outperform the assumptions in terms of defaults and recoveries or actively trade to build par then the actual cash flows produced by our CLO should exceed our current projections and over time all other factors remaining constant the actual return on the investment would be greater than the current effective yield. I would like to stress that the accounting yield as of June 30 are below the yields we projected when we underwrote these structures and as a general observation the CLOs that we have invested in have been performing in line with our underwriting expectations.
To this point, while only eight of the 13 CLOs have actually made quarterly distributions as of June 30, the cash was received on the CLOs have generally been in line with what we were expecting at underwriting or even exceeded in some cases. In fact, the average annualized cash-on-cash return for these investments that have made distributions is almost 20%. Importantly, even with over a little of half of our investments making distributions, our CLO portfolio produced $1.7 million in distributions during the quarter, which was in line with both our GAAP and estimated taxable income of $1.5 million and $1.4 million, respectively. I would caution you not to extrapolate this cash figure as cash flows can be lumpy at the outset, especially when they include initial CLO distributions.
While past performance doesn't speak to the future, I hope this gives you a sense of what is driving the reduction in the accounting yield and that ultimately to the extent our managers outperform these modeled assumptions, we will see it in the form of actual cash flows exceeding our projections and our income recorded for the future will reflect that performance.
In slides 11 and 12, I will review the portfolio and financing activity for the quarter. Moving on to slide 11, this summarizes the portfolio activity over the course of the quarter, as well as provides an overview of the yields. As you can see in the first chart, we focused on increasing our CLO investments in Q2. While we expect these allocations to fluctuate slightly over time based on market opportunities, we feel the current distribution of assets is a good reflection of what we currently plan to maintain in the future.
As you can see, we purchased almost $31 million of first lien loans during the quarter, which equates to a turnover of approximately 15%. While this may seem high, this was the first quarter we had the opportunity to optimize the portfolio following our ramp in the first quarter. We plan to continue to actively manage the portfolio and when we see opportunities like we did this past quarter when the primary markets pickup spread, we will rotate the portfolio according. The yields on the first lien loans we purchased was 44 basis points higher than the first lien loans we sold out of during the same period.
The chart in the middle takes our portfolio yield split across our various asset classes. The overall yield on the portfolio as of March 31 was approximately 6.39% versus the portfolio yield at June 30 of 6.33%. As we discussed earlier, the decline in the portfolio yield over the quarter is largely attributed to the CLO portfolio.
Turning to slide 12, we give a quick overview of our financing facility. Currently our mechanism for financing is a two-year $140 million revolving credit facility we have with Bank of America. The interest rate is generally LIBOR plus 1.8%. There is an unuse fee associated with undrawn commitments which is 0.75%. We typically can borrow at advance rates up to 80% depending on the underlying collateral.
As of June 30, our borrowing base was $150 million and the balance outstanding on the revolver was $128 million. We are pleased with the parameters and availability of our current financing and we will look to diversify our financing through capital raises and other means when market conditions allow. Our average cost of funding during the quarter, including unused fees and financing costs, was 2.36%.
Finally turning to slide 13, we have provided an overview of our business economics. This slide provides a basic snapshot of the earnings profile of our portfolio as of June 30 and March 31. As you can see, as of June 30 and March 31, the net investment income, ROEs are comparable at approximately 7.3%. So, notwithstanding the lower projected accounting yield in our CLO portfolio, our overall earnings capabilities hasn't changed materially. Moreover to the extent our CLO managers outperform the overall market as we expect them to, we should see this flow through in the form of increased GAAP a taxable income in the future.
With that, let me turn the call over to the operator for questions.
(Operator Instructions).The first question comes from Greg Mason with KBW.
Greg Mason - KBW
Great. Good morning, gentlemen. Mark, thanks for the good discussion on the CLO equity. To the extent that they are able to outperform these modeled expectations, how long does that take before it starts flowing back into the GAAP earnings? Is this a couple of quarters and we could see increase if they outperform? Or is it several years of improving outperformance before we see it impact the GAAP earnings?
Hi, this is John Erickson. You could see it in quarters not years, because if the cash flows are coming in higher than projected, we are going to have to sign the cash flows either to principal or to interest income. So it's quarters.
Greg Mason - KBW
Great. Thanks and you said no loans on non-accruals. Are there any assets that you do have some credit concerns about in your portfolio and maybe quantifying that, do have any assets marked below 95% of cost?
At this time, we don't have any -- there were no loans below 95% in the portfolio. From the portfolio was a high level of granularity, as I mentioned 80 basis points average issuer concentration. You saw the optimization that we go through. So we are constantly looking at the portfolio. And I would just stress that this is a very active credit approach that we take to managing ACSF. It's not a buy-and-hold static type of an approach.
Greg Mason - KBW
Great, and one last question. There has been some volatility here in July, high yield bonds have come under pressure. Can you talk about the loan market and what you are seeing here in July? And how is that volatility impacting you guys?
Yes. Hi, this is Dana Dratch. Overall the loan market, we have seen continued outflows from loan funds in the second quarter into July. I think one of the key offsets to that is continued strength in the CLO issuance markets. July was a strong month for CLO issuance, though we have largely seen that really and the volatility on the retail outflows has been offset by that. We have seen, generally speaking, we have seen spreads widen out in the primary market. And you know what we have also seen is some loans trading off, anywhere from 0.5 to 0.75 of a point or so. What we have typically seen in those loans trading off is they are typically larger issuers where the investors are kind of are investing across the cap structure, both the bonds and in the loans and a lot of times the investors will look to move the senior most piece of the cap stack in order to hold onto the yield of the piece and also the pieces that may be trading a little closer to par. So that's led to a little bit more softness in, what I call, some of the larger caps, probably syndicated names that tend to be maybe have slightly stronger credit ratings as well.
Greg Mason - KBW
Great. Thanks, guys.
Thank you. The next question comes from Chris Kotowski with Oppenheimer & Company
Chris Kotowski - Oppenheimer & Company
I guess related to the last question is, do you see anything fundamental underlying this weakness in the market? And is your inclination to have that make you more cautious? Or do you view this as a more of an opportunity to expand? And if it's the latter, how would you go about that?
Yes. So this is Mike Cerullo. We are not seeing anything on a fundamental credit basis. Overall that would cause us to have any concern with some of the recent softness. We do think its technical related as a Dana had indicated. So I think as we continue to manage the overall portfolio and look for relative value opportunities, we will rotate where we think it makes sense and we see better value in the primary market, given the widening spreads that we are saying. And one other point I would also notice, that we have a fairly large (inaudible) calendar, about 52 billion right now and that's working its way through our loan market currently. That will probably soften up a little bit going into the rest of August. So we will see what kind of an impact that has on the loan market.
Chris Kotowski - Oppenheimer & Company
This is Mark. I just wanted to give additional anecdotes to that point is, with the $52 billion new issue calendar coming to market, that allows us as a loan manager, kind of OID's available on the new issue markets kind of gapped out to 99% and 99.5% and earlier in the year into the second quarter, they were generally in the 99.5% to 99.75% range. So that gives us a lot of flexibility to optimize the portfolio. As Mike said, and Dana, where we see fit, we are keeping an eye on not burning NAV on the rotation. So a lot of flexibility and really its in relation to how we like to our manage our credit portfolio.
Chris Kotowski - Oppenheimer & Company
Okay, great. That's it for me. Thank you.
Thank you. The conference has now concluded. An archive of this presentation will be available on the ACSF's website and a telephone recording of this call will be accessible through August 18 by dialing 877-344-7529, using the conference ID 10049314. Thank you for joining today's call. You may disconnect. Have a nice day.
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