THL Credit (TCRD) Q2 2014 Results - Earnings Call Transcript

| About: THL Credit (TCRD)


Q2 2014 Results Earnings Conference Call

August 12, 2014, 08:30 AM ET


Stephanie Paré Sullivan - General Counsel and Chief Compliance Officer

James K. Hunt - Chairman of the Board

Christopher J. Flynn - Co-Chief Executive Officer & Co-Chief Investment Officer

Sam W. Tillinghast - Co-Chief Executive Officer & Co-Chief Investment Officer

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


Doug Mewhirter - SunTrust

Greg Mason - KBW

Jonathan Bock - Wells Fargo Securities, LLC


Good morning, and welcome to the THL Credit’s Earnings Conference Call for its Second 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, Chairman of the board, and Sam Tillinghast and Chris Flynn our co-chief executive officers 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 could 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 webcast replay of this call will be available until August 19, 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 second 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 Q2 Investor Presentation that we will refer to during this call.

We are pleased to have Sam Tillinghast and Chris Flynn with us this morning, who will lead much of the discussion today. As you know, effective July 31st, Sam and Chris were promoted to the co-CEO and co-CIO role. I will remain as the Chairman of the Board of Directors and look forward to working with Sam, Chris and the rest of the senior team that has worked closely together as a team for over seven years.

Sam and Chris will be sharing the leadership responsibilities and duties as co-CEOs and will continue along with Hunter Stropp President in their capacities as members of the investment committee.

On a day-to-day basis, Sam will oversee origination, administration and along with Hunter Stropp portfolio management across the platform. Chris will lead new investments across the five offices. Terry and Stephanie will continue in their capacities as COO and CFO and General Counsel respectively.

We are proud of the organization we have built with our focus of building long term value for share holders and it continues to be supported by the strength of our seasoned investment professionals and employees across all offices. Our five offices which include the addition of the Chicago and New York offices last year have expanded our origination footprint. A leadership transition was part of the textbook succession plan executed by our executive team over an appropriate period of time allowing us to maintain close continuity with shareholders, borrowers, lenders and our investment origination sources.

Sam and Chris will talk more on this, but we do see the market as being characterized by increased competition which has pushed yields lower, leverage higher and resulted more borrower friendly credit terms. What is important to know and emphasize is that we have since, as we have since our inception, continued to be patient and disciplined in our approach on credit and we will remain prudent in deploying shareholder capital and rigorous in protecting that shift.

With that I’ll turn the call over to Sam.

Sam W. Tillinghast

Thank you, Jim and good morning everyone. I’ll be providing overview of our activity this quarter and our financial highlights. Chris will cover our new investments and portfolio and Terry will provide a deeper dive into our financial performance. We finished the second quarter with 59 portfolio companies valued at $742 million after investing $69 million in three new transactions and seven follow-on investments in existing portfolio companies.

Realizations and repayments were $63 million. Based upon the timing of closing new investments and prepayments of existing investments, our net portfolio growth can be lumpy quarter-over-quarter as seen on slide 11 in the investor day. We believe there is some prepayment activity will continue to occur although the level remains difficult to predict as the economic outlook improves and re-financing opportunities present themselves at lower cost to capital.

We remain active in defending our deployed capital where it makes sense from a risk returned perspective. Jim mentioned the increased level of competition in our market, one of the best strategies to meet this challenge has been to increase origination activities. With the addition of our direct lending professionals in New York and Chicago last year, we increased the number of originated transactions substantially in the first half of 2014 as compared to the first half of 2013. We are however, selective about which investments to explore further based upon their risk return profile, our own industry expertise and how actionable the opportunity may be.

Overall, we found the most attractive opportunities, annual profiles and secured structures, recently either in second lien positions with appropriate lender protections or last-out unitranche structures. We have a growing number of relationships with commercial bank lenders with whom we regularly join forces to provide attractive unitranche financing. Also recently, we have seen attractive equity co-investment opportunities.

Now moving on to our financial highlights. Net assets as of June 30 were $450 million or $13.28 per share compared with $13.34 per share on March 31. The decrease was driven by changes in unrealized value and was offset by retaining $0.04 per share of earnings.

Overall, we are proud of our net asset value per share growth since inception which has been driven by accretive equity offerings, overall strong credit performance and retained earnings. A summary of this is reflected on page 12 of the investor presentation.

Our net investment income for the second quarter totaled $12.9 million or $0.38 per share compared to a dividend of $0.34 per share for the second quarter. We are pleased to announce that on August 7, our board of directors approved a quarterly dividend of $0.34 per share for the third quarter fiscal 2014 that is payable on September 30.

Now I’ll turn the call over to Chris to talk more about new investments.

Christopher J. Flynn

Thank you, Sam. As you can see in our press release we made $43 million of first and second lien debt in equity investments in three companies, Alex Toys, Aerogroup International and Thibaut each headquartered in New Jersey. In addition to these investments we made $26 million in follow on investments in seven existing portfolio companies, primarily in support of their expansion and growth.

The weighted average yield on new debt investments made in Q2 was 11.5%. The weighted average yield on all income producing investments in the portfolio as of June 30 was 11.1%. You will see that we have provided additional details on page 15 of our investor day presentation on the break down of yields overtime.

From a portfolio composition standpoint, if you refer to the page 25 of the investor presentation you will see that overtime we have continued to invest higher up in the capital structure and floating rate securities.

Over the last year, our asset mix has shifted from 54% in the first and second lien debt and 36% in subordinated debt, 71% in first and second lien debt and 20% subordinated debt. In addition to take advantage of rising in interest environment, since the second quarter of last year, we have increased the percentage of floating rate investments from 53% to 67% based on fair value.

Notable sales and repayments provide accretive fees and/or gains for the quarter included the repayment of NCM, the cost of sale of our debt investment in Blue Coat Systems which had a realized gain of $400,000 and gain from the sale of the 6% senior secured tranche of Hostway Corporation.

In terms of credit quality, our portfolio remains strong and consistent with the first quarter. As of June 30, 83% of our companies and our portfolio on a fair value basis received either a one or two credit score, which means they are meeting or exceeding our underwriting expectations.

We continue to have three investments on non-accrual, with two of those investments receiving a credit score of 4, and one receiving a credit score of 5. The three loans on non-accrual status as an amortized cost basis of $39 million or 5.3% of the portfolio which is unchanged form the prior quarter. For any companies with a three score or lower, we increased their level of engagement and require more frequent updates on performance and strategic initiatives in order to work toward a safe landing while maximizing our returns.

In terms of funding our growth, we are pleased with the $85 million expansion of our credit facility that was effective April 30 to $410 million from $325 million, in particular given we achieved reduction of pricing from L plus 300 to L 250 on a revolving portion of the loan and from L 400 to L plus 325 on a term loan portion. We also extended the maturity dates.

At the end of the quarter, we had $314 million of outstandings on our credit facility, or 0.67 times our net asset value. We continue to be comfortable with maintaining debt-to-equity levels in the 0.50 to 0.75 times range as we grow our portfolio with more first and second lien investments.

Given our portfolio mix today, we are comfortable at the higher end of this range. Future equity raises will be driven by our capital needs to fund attractive opportunities or leverage levels on the portfolio and whether our shares are trading above net asset value. We believe, we have demonstrated that history of growing our equity base responsibly and will continue to do so as we scale our business and position in the market place.

With that, I’ll turn the call over to Terry to talk through the financial performance.

Terrence W. Olson

Thanks Chris and good morning everyone. I’ll talk briefly on some additional financial highlights. The net investment income for the quarter was $12.9 million or $0.38 per share which is driven largely by a portfolio of growth and related interest income, dividends from our equity investments and fees from our managed funds and accounts.

From the portfolio we generated $23.7 million in investment income in the second quarter of which $20 million was from interest income on debt securities, which included $0.6 million of PIK interest, $1.3 million of prepayment premiums. $1.7 million of income was also from other income producing securities and $0.6 million from dividend income.

Other income of approximately $1.4 million included $0.8 million of fees from our managed funds and accounts, and $0.6 million was related primarily to amendment and other administrative fees and from our investments. The increase in investment income compared to the same period from the prior years is due to the growth of our investment portfolio and fees related to our managed funds and accounts offset by lower dividend income.

During the second quarter, we incurred $10.9 million of expenses including $2.9 million in base management fees, $2.6 million in general and administrative expenses, $2.8 million in fees and expenses related to our credit facility and $2.3 million of incentive fees which included the reversal of GAAP incentive fee income that will result in the benefit of $0.7 million.

In addition, we recorded an income tax provision related to our dividends and earnings on our equity investments held by consolidated blockers and excise taxes related to undistributed taxable earnings of $0.3 million.

During the quarter, we recognized net losses on our portfolio of $573,000 related primarily to $1 million loss and an escrow settlement offset by $414,000 in gains primarily related to the sale of Blue Coat that Chris had mentioned earlier.

Lastly, the unrealized value of our investments decreased by $2.9 million during the quarter and was driven largely by changes in the financial performance of certain portfolio companies and the reversal of net unrealized depreciation of investments repaid or sold.

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

Sam W. Tillinghast

Thanks, Terry. I’d like to close our formal remarks with a quick summary. We are pleased with the earnings growth this quarter that covers our dividend. We have $97 million of net portfolio growth year-to-date and will continue to be prudent and patient in deployment. The expanded capacity into our credit facility, coupled with proceeds from portfolio realizations provides us with the additional liquidity necessary to fund our near term investment opportunities.

Additionally, Chris and I are excited about our new roles, our seasoned team and Jim’s continued involvement with our board. We are also looking forward to developing closer relationships with all of you on this call.

At this time I would like to open the lines for questions, operator.

Question-and-Answer Session


Thank you. (Operator Instructions) Our first question comes from Doug Mewhirter of SunTrust. Your line is open.

Doug Mewhirter - SunTrust

Hi good morning, just a few questions. First, regarding your pipeline, it seems like you [fit] the pattern to allow your competitors this quarter that origination activity kind of tapered off a little bit from a strong start to the year, but a lot of your competitors also remarked that they had a lot of deals that just hadn’t closed yet or just a lot of activity in general. Is that similar to you or maybe you are sitting on a pipeline that just a few just didn’t make it through or are you a little bit more cautious with regard to what you’ve –originated?

Christopher J. Flynn

Doug thanks for the question. This is Chris. I think if you look at the pipeline, the number of opportunities that we’re seeing is robust. It’s just our hit ratio is substantially lower, just given the credit quality and the metrics that we want to see as we look to deploy capital. If you look at our pacing maybe two or three investments that had you know rolled into Q3 versus Q2 but nothing substantial.

Doug Mewhirter - SunTrust

Okay, the second question is really quick. The investments you’ve made this quarter what was the sponsored, unsponsored split or were they all one or the other?

Christopher J. Flynn

Predominantly sponsored Doug.

Doug Mewhirter - SunTrust

Okay and just my last question. There seems to be a lot of demand for capital in the energy patch. But I know you have a Houston office, are you seeing a lot of activity there or is there – are there attractive opportunities there, do you expect sort of good things from that office?

Sam W. Tillinghast

Yeah, this is Sam Doug. We do see a lot of energy transactions having the Houston office. In fact we closed one earlier this year, but what we are also seeing there is we’re seeing increased amounts of leverage being put on the energy companies, really and we don’t want to change our credit standards as far as energy is concerned or really any of the credits that we see. So we’re seeing players they are committing into that space, lending into that space that we think we don’t have a history, don’t have their appreciation for how [difficult] that sector can be.

Doug Mewhirter - SunTrust

Hey great. Thanks that’s all my questions.


(Operator Instructions) Our next question comes from Greg Mason of KBW. Your line is open.

Greg Mason - KBW

Great, good morning guys. I wanted to just kind of talk about how you are pursuing the next couple of quarters. The pipeline is strong and you are seeing attractive investment opportunities, but your near kind of your max leverage and you talked about you’ve been patient with equity raises, you’ve only done them at nice premiums to book value, so when we put all that together it seems like you need more capital but you’re right now with where the stock prices and I’m sure you can’t be happy with raising capital at that price. So, can you just talk to us about how you know your thought process for managing kind of the rest of the year on a capital basis, from a capital basis standpoint?

Sam W. Tillinghast

Well Greg, thanks for the question. As we look at the amount of liquidity we have coupled with potential repayments from this natural portfolio term, we think we have sufficient capital to effectively execute on the pipeline as it stands today. Obviously we’re going to be prudent as it relates to structure leverage and price as we’re investing what appear to be finite dollars at this stage, as it relates to the stock price we’d obviously like to see it higher and if it does move higher I think we’d opportunistically you know raise capital as we have in the past assuming that it makes sense.

Greg Mason – KBW

And then just on that last point, you have permission to issue stock below book, I mean with the stock trading kind of right at book value, net of underwriters fees, it would be below book to day if you choose to do a deal, what is your view given that you have permission to issue below book, doing a below book equity raise?

Sam W. Tillinghast

Greg, this is Sam again. We have no intention to raise equity below book. We work with – we’re not in such a rush to grow the portfolio that we would do something that would be you know in the shareholders long term best interest.

Greg Mason – KBW

Okay, great. And then one question on the portfolio, you said a lot of your add on capital was for growth, but one company Connecture looks like you added a lot to it and the yield went up from call it 11 to 13.5 just in a yield compressing environment anytime we see yields go up it raises our eyebrows a little bit, so can you maybe talk a little bit about Connecture?

Christopher J. Flynn

Yeah, this is Chris again. Greg, I mean broadly speaking we wont’ comment on any individual business other than to say that we like this opportunity the company is investing a lot in its growth and they needed some incremental growth capital where we priced it accordingly.

Greg Mason – KBW

Great. Appreciate it, thanks guys.


Thank you. And our next question comes from John Bock of Wells Fargo. Your line is open.

Jonathan Bock - Wells Fargo Securities, LLC

Good morning and thank you for taking my question. Perhaps diving in a little deeper to the equity issuance question that I think Greg was getting at. Sometimes we’ve seen some Managers really stub their toe in a big way. It’s not merely raising at a premium than [that] some people were more than happy to raise 104, 106 but is the effective cost of that equity coupled with their cost to debt etcetera that when compared to what they are getting on new assets disappointed a number of people.

And so, kind of rephrasing the question, at what point you know I mean in terms of what you are seeing in the market, do you believe that issuing equity is something that could be considered, I won’t use the term meaningfully because that’s not possible, but adequately accretive to the shareholders in terms of the risk that they are taking to fund these new deals in this environment. So give us your thoughts on the required rate of return you would need to deploy at in order to make an equity issuance accretive and at what levels make sense for you and your investors?

Terrence W. Olson

Jon, this is Terry. It’s a great question and we appreciate it. I think, there’s a couple of ways of looking at this. Your point about looking at it specifically on you know absolute return on specific dollars of equity raise leverage appropriately relative to the dividend level of which you know you currently need the support is certainly one way of looking at it. I think another element that needs to be added to that equation more broadly and I’ll let Chris and Sam weigh in on here as well is that the overall return on equity of the shareholder is well is something that we think should be looked at relative to the dividend level as well, because if you think about it there’s a constant flow of these and upside flowing through the portfolio overtime that shouldn’t necessarily be looked at on its own just as looking at specific investing specific new capital shouldn’t be looked on its own.

So I think if you look at those things collectively at a 10% ROE we feel pretty good about being able to cover call it at a price we’ll be raising capital I’d call it a 9.5% dividend yield. So that is slightly accretive overall. That being said, I think if you take it down to a level of granularity that you suggested, I think if we can talk a little more offline on the math and all depends on how you look at this, if you look at equity raised, 11.7 times we are at today and you’re putting assets to work, you call it 10.5 or [North] percent. If you look at our fee structure, I think you get to something that’s you know to your words marginally accretive as well. So I think from an economic perspective, I think you can make it work with yields in that 10.5%, 11% range and leverage levels at 0.7%. Chris, if you have anything more broader to that.

Christopher J. Flynn

Yes, Jon Terry’s view was accurate. If you look at he math on individual investments when you include the yield or the coupon if you will coupled with all the fees that you have been generating very high ROEs on their own. I guess the other thing I would add is, if you look at our business and this is the business we have to have capital to invest to support our relationships and support the five office footprint that we have and it’s trying to judge the long term value of what the origination that worked that we put in place versus one individual investment on a math equation we think is not the long term view that you want to take as you look to expand and build the platform and be meaningful to our clients. Because again, at this end of the market lower middle market, credit your it’s a very relationship driven business and we need you know we need to be able to think about the value of those relationships overtime as long as that drives a lot of shareholder value there which may or may not come back from a basic math equation.

Jonathan Bock - Wells Fargo Securities, LLC

That makes complete sense. And you know there’s no perfect answer to the question and Terry we do definitely want to give you obvious credit for the higher returns that are above your stated coupon and we get the [fungibility] of numbers. I’d say that the investor community has often heard those comments from other management teams and has often then disappointed.

So I mean its good to know that there are different people taking a track its just a matter of looking at things holistically because sometimes that’s been seen as the magic [indiscernible] you have to make things accretive, it doesn’t necessarily occur, although in your case you do have a consistent track record that demonstrates that you are able to find those fees.

In terms of a second liquidity bucket, we could talk about equity raise, talk about appropriateness going to 0.7, you mentioned I believe Chris just talking about fulfilling your obligations and being relevant you know that makes complete sense. And just curious because growth capital doesn’t necessarily need to come from equity issuance it could come from what you generate internally via sales etcetera. What amount when you think about that of turning the portfolio do you believe you have available or perhaps have the ability to influence a capital refinance decision etcetera to allow you to equate a pipeline in the event the equity markets aren’t open?

Sam W. Tillinghast

Hey Jon, this is Sam. I think its probably around – these are rough numbers, probably around 10% of the portfolio is fairly liquid, if we wanted to sell off we needed to raise additional capital that way to a rough number.

Jonathan Bock - Wells Fargo Securities, LLC

Okay, it’s good to know and then finally if you know if we think about some verticals where THL Credit has some strong expertise, CLOs is a vertical through the senior loan strategies team that you’ve added. Curious on what you see as the opportunity in the asset class as well as the potential for growth given that it’s a bit of a high return proposition and then also just as a side note, what’s the accrual rate in general now that you kind of think is appropriate to be accruing income on CLOs in this environment?

Sam W. Tillinghast

Jon, it’s for most of the year, we saw all the returns on CLO equity tighten up quite a bit and so we’ve really -- stayed on the sidelines. As you know we’ve got a CLO Manager based in Chicago a couple of very experienced individuals in New York as well. And they are always on the look out for management teams that they know well and situations where we can invest, we think at a very value added position in new CLOs.

Recently those crisis have widened a little bit, we think that may be some attractive opportunities between now and the end of the year. At least we’re on the look out for them. Right now, the portfolio is less than 5% CLO equity, you know my guess is we have room for maybe one or two others over the next six to nine months. But its not an area that we’ll do a lot then we’re really just opportunistic in that area, given that our team knows to space that well.

Christopher J. Flynn

And Jon, I’d add just to your point about overall yield. I think we’re at [14] to an average just last quarter we’ve come down to about 13.5, you know could there be a little bit more there I think it will depend on several factors you can appreciate we see some wide end of the spreads a lot of the overall return is dictated by other components the fall rates, prepayment rates within the portfolio. So we’re very mindful of it, we’ve seen some compression, could see a little more but you know I wouldn’t want to speculate on the exact amount.

Jonathan Bock - Wells Fargo Securities, LLC

Okay guys, thank you very much.

Sam W. Tillinghast

Thanks, Jon.

Christopher J. Flynn

Thanks Jon.


Thank you. And I’m showing no further questions at this time.

James K. Hunt

Okay, thank you everyone. We appreciate your questions and look forward to speaking with you next quarter.


Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.

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