American Capital Senior Floating, Ltd. (NASDAQ:ACSF)
Q4 2015 Results Earnings Conference Call
February 09, 2016, 11:00 AM ET
Erin Carnie - IR
Malon Wilkus - Chairman and CEO
Sam Flax - EVP and Secretary
John Erickson - CFO and EVP
Mark Pelletier - President and Chief Investment Officer
Michael Cerullo - SVP and Head of Research
Dana Dratch - SVP and Head of Trading
Christian Toro - VP
Mark Lindsey - Chief Accounting Officer.
Greg Mason - KBW
Chris Kotowski - Oppenheimer
Good morning and welcome to the American Capital Senior Floating Fourth Quarter 2015 Shareholder Call. [Operator Instructions]
I would now like to turn the conference over to Erin Carnie in Investor Relations. Please go ahead.
Let me begin by apologizing for some technical difficulty we have this morning and now we're getting start a little late. Thank you, Nan, and thank you all for joining American Capital Senior Floating's fourth quarter 2015 earnings call.
Before we begin, I'd like to review the Safe Harbor statement. This conference call and corresponding slide presentation contains statements that, to the extent 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 including 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 February 23, by dialing 877-344-7529 or 412-317-0088, and the conference ID number is 1008466.
To view the slide presentation turn to our website, acsf.com and click on the Q4, 2015 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, Chair and Chief Executive Officer; Sam Flax, Executive Vice President and Secretary; John Erickson, Chief Financial Officer and Executive Vice President; Mark Pelletier, President and Chief Investment Officer; Michael Cerullo, Senior Vice President and Head of Research; Dana Dratch, Senior Vice President and Head of Trading; Christian Toro, Vice President; and Mark Lindsey, Chief Accounting Officer.
With that I’ll turn the call over to Mark Pelletier.
Thanks Erin. Thank you all for participating on today's call. Many of the challenges we saw going into Q4 remains throughout the quarter. The global risk off sentiment coupled with heightened credit concerns and reduce liquidity caused prices to weaken throughout the fourth quarter.
The result was a general repricing across the loan and CLO markets. We will discuss the Q4 market dynamics in greater detail later in the call, but it's important to note that while the negative pricing pressure resulted in NAV decline, the cash flows from our portfolio in particular, cash flows from our CLO investments remained robust.
As we have mentioned on our Q3 call, two favorable events occurred during the quarter. First, we announced an amendment to our credit facility with Bank of America. The amendment extends the maturity of the facility by three years, and is expected to result in a lower cost for funding.
Second, our Board of Directors approved an amendment to our management agreement which includes a five-year extension to the 75 basis point capital expenses. This amendment will not become effective until approved by our shareholders which we will submit for a vote at the next annual meeting. In the interim our manager has agreed to temporarily extend the 75 basis point cap on expenses until our shareholders have a chance to review and vote on the proposed amendment.
With that, let me turn to Slide 4 to discuss the Q4 2015 highlights. Net investment income for the quarter was $0.31 per share or $3.1 million, a decrease from the Q3 2015 net investment income of $0.33 per share.
Net assets from operations declined $1.44 per share or 14.4 million driven primarily by the depreciation in our investment portfolio during the fourth quarter. This decline is a function of high uncertainty in the market which we will discuss in more detail later on the call.
Our ending NAV for the quarter was $11.79 per share or 117.9 million, a $1.74 per share decrease from the September 30 NAV of $13.53 per share.
We are pleased to announce that our Board of Directors has declared monthly dividends of $9.7 per share for February, March, and April which equates to a quarterly dividend run rate of $0.29 per share and is consistent with the Q4 dividends. When expressed as a function of our closing price on December 31, our annualized dividend yield is approximately 11.8%.
As of December 31, ACSF had a $229 million investment portfolio comprised of 170 million of first lien floating rate loans, 22 million of second lien floating rate loans and 37 million of CLO equity.
Turning to Slide 5, the portfolio yield as of December 31, was 6.37%, down 44 basis points from the September 30 yield of 6.81%. The decrease in the portfolio yield is attributed with decrease in yield on the CLO portfolio.
The CLO portfolio yield decreased due to reduction in projected cash flows. Our total average cost of funding for the quarter was 2.32% based on debt outstanding as of December 31, it was comprised of 2.06% for interest expense, 17 basis point for unused facility fees and 9 basis points for amortization of debt financing cost.
This was a nine basis point decrease from our September 30 cost of funding of 2.41%. Our debt-to-equity ratio remained stable at 0.93:1, up from 0.92:1 at September 30. As we previously mentioned, we recently amended our credit facility with Bank of America to extend the maturity by three years and the refinancing is projected to lower our anticipated borrowing cost, primarily from a lower amortization expense for upfront fees.
Also during the quarter, our Board of Directors has approved an amendment to our management agreement to provide for a five-year extension to the 75 basis point cap on other operating expenses. In exchange from modification to the management agreement, allowing for certain non-investment professional compensation cost to be allocated to the company. Though these additional cost would be included in the expense cap for the first five years.
This proposal is subject to shareholder approval at our upcoming annual meeting. In the meantime, ACSF's manager has agreed to temporarily extend the expense cap until shareholder’s vote on the amendment.
Turning to Slide 6, we’ve provided some highlights for the full year. While we encountered a challenging market during 2015, we remain active and invested 107 million into 82 new loan obligors and 5 new CLOs.
We increased our year-over-year net investment income to a $1.27 per share in 2015 from a $1.9 per share in 2014, which in turn allowed us to declare a $1.16 per share in dividends, a $0.13 increase from 2014. The dividends equate to an approximately 11.8% return on a closing share price of $9.83 at December 31.
Slide 7 highlights the quarterly trends in our portfolio composition and returns since Q4 2014. The movements in our portfolio allocation were modest this quarter. Yields in spreads decreased primarily as a result of updated cash flows on the CLO portfolio. Overall, net investment income remained strong.
Now I’ll turn the call over to Dana Dratch, Senior Vice President and Head of Trading to provide an overview of the market.
Turning to Slide 8 in a continuation of trends we saw in the third quarter, prices in the senior floating rate loan market commonly referred to as a leverage loan market declined during the fourth quarter while new issue clearance spread widened.
The average bid of the S&P/LSTA leverage loan index, which we believe is most indicative of our loan portfolio closed at 91.26 on December 31, down from 94.21 on September 30. The index generated a 2.1% loss in the fourth quarter after dropping 1.35% in the third quarter.
The weak second half lead the index finishing the year down 0.69%. Only the second time in 19 years when the index generated a negative annual return.
Weakness in the commodities, retail, and utility sectors were key drivers for the negative return in the fourth quarter. Additionally, loan prices were hurt by technical factors during the quarter namely large outflows from retail loan funds, a slowdown in CLO issuance, and a slowdown in repayment rate.
Investors appeared focused on moving up the quality spectrum during the fourth quarter as Double B rated loans outperformed Single B rated loans, and first lien loans outperformed second lien loans.
Slide 9 illustrates volume pricing and default trends in the leverage loan markets. Total loan volume was down sequentially but up over prior year activity. Corporate M&A, and to a lesser extent, LBO volumes remained solid while recapitalization and refinancing volumes declined significantly.
As the chart in the right illustrates, while the trailing 12-months default rates to the fourth quarter remained relatively benign at 1.54%, we note that the default rate hit a nine month high in December.
According to data from the Loan Syndications & Trading Association, secondary trading volumes were approximately $146 billion in the fourth quarter, were up slightly from $139 billion in the third quarter of 2015, and down from $153 billion in the fourth quarter of 2014.
As loan prices weakened, bid-ask spreads widened and trading activity narrowed to a smaller pool of loan. As a result of lower trade activity in the second half of the year, total trading volume in 2015 fell about 6% to $591 billion down from a record $628 billion in 2014.
I will now turn the call back over to Mark to discuss our portfolio.
Turning to Slide 10, as of December 31, we had a $229 million portfolio at fair value, the 170 million or 74% in first lien loans, 22 million or 10% in second lien loans, and 37 million or 16% in CLO equity.
The chart on the right shows the yield at cost for the entire portfolio at 6.37% as of December 31, comprised of 5.38% weighted average yield on the loan portfolio and a 10.04% yield on our CLO equity.
As of December 31, the portfolio was diversified across 143 portfolio companies with an average issuer concentration of 70 basis points and a maximum issuer concentration of 1.5% of the total portfolio. Overall we feel good about the mix and granularity of our portfolio.
Turning to Slide 11, we take a closer look at the loan portfolio. As of December 31, our loan portfolio was valued at $192 million and was invested across 128 obligors representing a diverse mix of industries. The loan portfolio yield remains favorable during the quarter at 5.38%. Our entire loan portfolio was comprised of floating rate loans that have LIBOR floors of approximately 1%.
Now will turn the call over to Mike Cerullo, Head of Research to discuss credit quality.
On Slide 12, we have presented some information regarding the overall credit quality of ACSFs portfolio. We are pleased to report that as of December 31, 2015, we had no loans that were in payment default and only one investment of non-accrual representing less than 25 basis points of the loan portfolio at $0.01 per share and interest foregone.
This investment continues to pay interest per its loan agreement. A credit that was on non-accrual during Q3 restructured during the fourth quarter where we took a realized loss of $0.60 on the dollar and received a post bankruptcy senior secured loan along with equity in the company.
Approximately 75% of the loan portfolio has a facility rating of at least B or higher, which is a decline from 79.5% at the end of the September third quarter end.
The change in ratings was driven primarily by ratings migration as there were several names that were downgraded during the quarter, including a few names related to commodities, as well other downgrades within the portfolio.
We have talked about the continued volatility and weakness in the loan market earlier in our presentation. And our portfolio was not immune to the overall trends in the market. During the quarter, ACSFs loan portfolio price declined from 96.9% as of September 30 to 92.7% at December 31 or a decline of 4.2%.
The portion of our portfolio with direct and indirect exposure to the commodity sectors, which include names primarily classified as metal and mining and oil, gas and consumable fuels has remained steady at approximately 4% and we continue to do this exposure as manageable.
The price of oil and the impact on global markets and economies remains very topical. Oil prices continued their descent in the latter half of Q4 and declined materially coming into 2016. WTI fell from $0.459 to $0.374 per barrel between September 30, 2015 and December 31, 2015, and in January 2016 descended until the low 30s even briefly piercing below $30.
Our strategy to create a granular portfolio prevents over concentration in individual industries or names and this is the case for our energy exposure as well. As part of our overall portfolio monitoring process, we spend a considerable amount of time focusing on such names to ensure that we are still comfortable with the investment pieces for each position.
Considerations include our issuer's industry specific trends, whether our issuers have a defensible market position, the free cash flow generation, long-term value, any structural protections and of course the relative value of each position.
Now, I will turn the call back over to Mark.
On Slides 13 and 14, we provide an overview of the CLO equity portfolio. We continue to stay invested in granular positions across the diverse number of issuers and managers. As of December 31, the CLO portfolio was valued at $37 million or 52% of face value versus our accounting cost basis of approximately 78% of face value.
Cost basis is down from 81% last quarter and is a function of the accounting treatment we use, which applies a portion of the regular quarterly distributions as a return of capital to reduce our cost basis overtime. As long as the cash distribution is received are in excess of the GAAP income, cost basis will amortize down. During the quarter we received just over $3.7 million of distributions from our CLOs and reduced our cost basis by $1.9 million.
The resiliency of the CLO market was tested on multiple fronts in 2015. Regulatory developments, credit market volatility and credit weakness in some sectors of the U.S. economy. Despite a difficult second half of the year, equity distributions were stable and remained strong.
As of December 31, the weighted average accounting yield was 10.04%, down from 12.95% as of September 30. As we indicated earlier on the call, the CLO yield decreased due to a decrease in projected cash flows on the CLO portfolio. Due to the impairment of five CLO investments, ACSF recognized a $4 million other than temporary impairment or OTTI.
As the result of the OTTI, we will continue to recognize income from those investments over their life, but ACSF will amortize $4 million less cost basis over the life of the impaired investments and we will record a $4 million realized loss upon the sale or redemption of the investments.
As a reminder, every quarter we update cash flow projections for 8 CLO investments and then calculate the accounting yield based half of those projections. This accounting yield is then used to record revenue for the CLO portfolio in the following quarter. Therefore, the decline in the reported yield on the CLO portfolio is directly a result of our updated cash flow forecast.
More specially, the assumptions related to defaulted aspects were significant contributor to the decline of forecasted cash flows and the corresponding accounting yield this quarter. However, I would note that the defaults in the portfolio remain below long term historical averages and despite a limited pickup in the amount of defaulted assets, larger realized losses have not materialized at this time and CLO cash distributions remain strong.
For few quarters now, you've heard us talk about the strength of cash distributions from our CLOs. I would like to once again point out one method that we think highlight this. If you look at the last row of the table for those CLOs that have begun to make quarterly distributions, we show the cumulative cash receipt as a percentage of the original cost.
As of the end of Q4, we have received cash distributions of approximately 35% for original cost for 19 of our CLOs. Set differently in approximately two years, we have received over one third of our original capital invested. I think this metric exemplifies what we mean when we say CLO equity can produce strong cash flows.
Turning to Slide 14, our CLO portfolio experienced $8.9 million of depreciation during the quarter. The decline in fair value was largely driven by volatility at the macro level, increased investor risk aversion and deteriorating liquidity. While valuations experienced some downward pressure, cash distribution are stable and remain strong, remain constructive on the CLO market and continue to consider attractive opportunities.
Also it's important to note that we're able to keep our leverage within a target range through trading of the loan portfolio in response to a somewhat volatile CLO equity pricing.
Slide 15 summarizes the portfolio activity for the quarter and the associated yield for each corresponding activity. As you can see in the first chart, the portfolio rotation this quarter was relatively modest due to lower primary loan issuance, high-end market volatility, and reduced secondary loan market liquidity.
We did have $18 million in purchases and approximately $31 million in sales and repayments. The bottom chart shows the yields for the quarter. We saw a 12 basis point increase in our loan portfolio yield and we saw a 44 basis point decrease in the overall portfolio, which is attributed to the CLO portfolio portion.
On Slide 16, we have the financing overview for the quarter. The facility was amended during the quarter to extend the maturity date for three years, reduce the facility size from $140 to $135 million and then unused facility fee of 75 basis points when utilization is below 90%.
The interest rate remains the same at viable plus 180 basis points or base plus 80 basis points. As of December 31, ACSF had $110 million outstanding. We experienced a 10 basis point average cost of funding decline attributed to the amended credit facility. Further reductions may occur where ACSF was able to take advantage of the unfunded commitment fee holiday.
With that, let me turn the call over to the operator for questions.
[Operator Instructions] Our first question comes from Greg Mason of KBW. Please go ahead.
Great; good morning, guys. Thanks for taking my questions. First, on the CLO equity yield, it fell from 13% to 10% this quarter. Are there any one-time items that get involved in that calculation? To say it another way, let's just say the liquid credit markets remain flat from here. Is that 10% number likely to change over the next 12 months if there are no changes in the credit market?
Hi, Greg, this is Mark Lindsey. We reforecast our cash flows on a quarterly basis and that yields calculated at the end of each quarter based on those projected cash flows. If there is no change in those projected cash flows then our yield would remain relatively stable.
Okay. Then could you also talk about just some of the changes in the CLOs relative to the changes in the liquid markets? We were a little caught off guard by that. In the third-quarter the LSTA was down 2.4%, the price declines of CLOs were down 13% of your mark-to-market, and the yield fell by 170 basis points.
In the fourth quarter the LSTA you said declined 2.1%, so not quite as bad as the third quarter, yet the yields fell by 300 basis points and the prices declined by 20% instead of 13%. So just if you could give us some additional color around the magnitude of the CLO equity changes in the fourth quarter, that would be helpful.
Yes. We would say that we saw actually more volatility and a steeper price drop in the loan market in Q4, most notably in the commodity sectors where we saw - this is broadly speaking, across the market - a lot of those names really don't have any bid and prices fell anywhere 20, 30, 40 points.
So it's the subsector of the market that's trading below 70 - more than doubled during the quarter. That was one of the key drivers. But headline numbers, quarter-over-quarter, the overall average market was down steeper in Q4 than in Q3.
Hi Greg, it's Christian Toro. I think the other thing to consider as well is there was a lot less activity in the secondary in Q4 versus Q3. So again when our valuation group project or estimates value they take that into consideration. So with less liquidity out there, there is probably, you could say there is not only a credit premium being added, but also a liquidity premium as well.
Okay, great. And then one last question on the other-than-temporary loss that you're taking on the impairment of the CLOs. I guess one of my questions is, why don't you or why wouldn't you just amortize more of the cash flows to reduce the cost basis so you don't have the loss at the end? Just curious of - is there some kind of GAAP requirement that's requiring this $4 million OTTI? Or what's behind that, I guess?
Sure. Hi, Greg, this is Mark again. Yes, this is a GAAP requirement. There is a decision-tree process that you go through underneath GAAP. And the first step is, when you have fair value that is less than your amortized cost basis, there could be an indication of impairment. You then take a next step, and as long as you're not intending to sell or will be required to sell, you go to the third step.
And then the third step of the test is, do we have a reduction in our projected cash flows that could indicate a credit impairment? And then you're required to record other-than-temporary impairment at that point in time.
GAAP requires, because we fair value our CLO investments on our balance sheet, that the way it flows through our income statement is at the end of life or at redemption we'll have $4 million of cost basis that has not been amortized. And at that point, on redemption, we would take a realized loss. That's a requirement under GAAP, so we don't really have a choice on how we handle the amortization of that $4 million cost basis.
Okay. Great. I appreciate it guys. Thanks.
Our last question comes from Chris Kotowski of Oppenheimer. Please go ahead.
Actually that last question was mine. But it just - yes, historically the thing one would have done is take cash flows against principal when a loan is in difficulty. You're required to do the opposite, almost, it seems like?
For the guidance - these aren't loans, and the guidance we're required to follow on these types of securities. If we carried these at cost basis on our balance sheet we would normally take that impairment. A normal company or a non-fair-value company would take that impairment at the date of impairment and reduce their cost basis.
Our balance sheet, we reflect these CLO equity investments at fair value and, mechanically, that's how we have to account for it. This is how we accounted for this portfolio in the previous recession, and it's just a requirement under GAAP. I know it gives somewhat of an odd answer. But it's how we have to account for it.
Okay. And the $4 million of decreased cash flows was that driven by – you're looking through to the underlying assets in there and saying, okay there is so much of thus-and- such, energy credits or what have - how did you calculate the $4 million shortfall.
Chris that’s exactly. So in the modeling assumptions we will take a look at the portfolio for each individual CLO and assess sort of the risk profile back in that particular portfolio. So, when we compare Q3 to Q4 the difference there and the reason for the most part why these five securities have lower expected future cash flows was the higher hold percentage of commodity means in general.
I think one of the things I’d to highlight and it goes back to the comments that Mark made earlier, is about the frontloaded nature. The frontloaded cash flow nature of these vehicles we still expect from an IRR perspective to come out whole on these positions. So they all have the positive IRRs because we have collected so much of the cash flows up front.
So this is purely an accounting norm, or an accounting methodology as required by GAAP but we do still expect a positive IRR on these returns, on these particular facilities or investments.
Okay, thank you. That's it from me. Thank you.
Thank you. We have now completed the question-and-answer session. I'd like to turn the call back over to Mark Pelletier for concluding remarks.
Thank you. And that concludes our call for today. We appreciate everybody's continued interest in ACSF and we look forward to talking to you next quarter. Thank you.
The conference is now concluded. An archive of this presentation will be available on ACSF's website, and a telephone recording of this call can be accessed through February 23, by dialing 877-344-7529, using the conference ID 10078466.
Thank you for joining today's call. You may now disconnect your line.
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