KCAP Financial, Inc. (NASDAQ:KCAP)
Q2 2016 Earnings Conference Call
August 02, 2016 09:00 AM ET
Dayl Pearson – Chief Executive Officer
Ted Gilpin – Chief Financial Officer
Andy Ellner – JMP Securities
Troy Ward – Ares Management LLC
Good morning, ladies and gentlemen, and welcome to the KCAP Financial Incorporated Conference Call. An earnings press release was distributed yesterday. If you did not receive a copy, the release is available on the company’s website at www.kcapfinancial.com in the Investor Relations section. As a reminder, this conference call is being recorded today, Thursday, August 4, 2016. This call is also being hosted on a live webcast which can be accessed at our company’s website at www.kcapfinancial.com, in the Investor Relations section under Events.
Today’s conference call includes forward-looking statements and projections and we ask that you refer to KCAP Financial’s most recent filings with the SEC for important factors that would cause actual results to differ materially from those projections. KCAP Financial does not undertake to update its forward-looking statements unless required by law.
I would now like to introduce your host for today’s conference, Mr. Dayl Pearson, President and Chief Executive Officer of KCAP Financial. Mr. Pearson, you may begin.
Thank you. Good morning and thank you for joining KCAP Financial for a review of our Second Quarter 2016 Results. Today, I will review some of the important highlights and activities from the second quarter as well as provide some context for our direct lending business and the performance of our Asset Manager Affiliates. I will then turn the call over to our Chief Financial Officer, Ted Gilpin, who will provide a brief recap of our second quarter operating results and our financial condition at the end of the quarter. We will then open the line for your questions at the end of the call. A presentation outlining a few of our key accomplishments during the quarter can be found on the IR section of our website.
To start let me provide a brief recap of some of the important highlights from the second quarter which are summarized on slide three of our earnings presentation. For the second quarter of 2016, our NII was $0.14 per share. Our second quarter shareholder distribution was $0.16 per share consistent with the $0.15 paid in the first quarter as well as the fourth quarter of 2015. I would now like to discuss our performance of our loan and securities business and Asset Management Affiliates in more detail.
Turning to Slide 4, during the quarter we invested approximately $10 million in new originations. This is primarily funded by repayments and sales placeholder assets. These new loans had a yield generally comparable to the assets they replaced. Credit quality over the portfolio continues to be strong with only one nonaccrual loans representing less than 1% of the company’s total investments at cost at June 30, 2016. At the end of the first quarter, we placed one new loan on nonaccruals subsequently we decided to sell the acquisition due to concerns about the restructuring process. We sold that loan in Q2 at 85 compared to our Q1 mark of 79.
KCAP stands out among most of our peers with very low nonaccruals as well as a limited exposure to the oil and gas industry. Most of the marks on our loan portfolio are related to market issues and not serious credit issues. In the past 7.5 years, we’ve originated over $1.2 billion in new loans with two defaults over that period of time, including the one mentioned above. As always we continue to maintain our standards as I’ve previously said and we’ll not sacrifice credit quality in order to meet short-term income goals. Subsequent to the end of the quarter, KCAP monetized its investment in DBI which included a realized gain and warrants of approximately $4.5 million consistent with our market at the end of the quarter.
In terms of the market for our new CLO funds, the environment has improved in Q2 and continues the positive momentum into Q3. We continue to warehouse for our next CLO fund and have increased our first loss warehouse capacity in Q3 due to the improvement in the loan in the CLO market. Projected CLO issuance although lower than 2015 highs has increased recently indicating the resiliency and appeal of the CLO product, we remain very cautious on asset selection. We continue to be positive regarding our ability to issue a new CLO fund in the future.
As of June 30, 2016, our weighted average mark-to-market value to par on our debt securities portfolio was 95 up slightly from 94 in the first quarter of 2016. As noted earlier, we have observed loan market improvement in Q1 to Q2 with continued improvement into Q3. As far as the CLO portfolio, our weighted average mark-to-market value to par was 57 as of June 30, 2016, an increase from the weighted average mark-to-market to par of 55 for the first quarter for the same non-redeemed or sold CLOs.
Our 100% ownership with our Asset Management Affiliates was valued at approximately $45 million based on their assets under management and positive and perspective cash flows at June 30. Our investment portfolio at the end of the second quarter totaled approximately $373 million. At the end of the second quarter, debt securities totaled approximately $265 million and represented about 71% of the investment portfolio. First lien loans now represent 73% of the debt securities portfolio and junior loans 13%. All CLOs managed by KDA and Trimaran continue to be current on equity distributions and management fees. The stable income stream from our Asset Manager Affiliates allows them to make periodic distributions to us. During the second quarter, they made a distribution of $850,000 to the company.
Additionally as of June 30, 2016, our Asset Manager Affiliates had approximately $2.7 billion of par value assets under management which is consistent from the end of the fourth quarter 2015. As always, we continue to evaluate equity and debt financing options which will allow us to focus on continued balance sheet growth, increasing net investment income, and dividend distributions.
And now, I’ll ask Ted Gilpin, to walk through the details of our financials.
Thank you, Dayl. Good morning, everyone. As of June 30, 2016, our net asset value stood at $5.45, down from $5.50 at the end of the first quarter of 2016 and down from $5.82 December 31, 2015. As mentioned, the company declared a $0.15 distribution in the second quarter of 2016 consistent with the first quarter as was in the fourth quarter of 2015. Net investment income was $5.1 million or $0.14 per basic share for the second quarter of 2016 up from $4.8 million or $0.13 per basic share for the first quarter of 2016 and down from $5.8 million or $0.16 per basic share for the second quarter of 2015.
At this point, I’d like to discuss the details of our second quarter results for 2016. Interest income on our debt securities for the quarter ended June 30, 2016, was $5.2 million compared to $5.7 million for the first quarter 2016 and $5.9 million for the second quarter of 2015. Our debt securities portfolio contribution to total investment income currently stands at 54%. Investment income from CLO fund securities was $3.4 million in the second quarter of 2016 compared with 3.2 million in the first quarter of 2016 and $4 million in the second quarter of 2015. Dividend income from our Asset Manager Affiliates was $850,000 in the second quarter of 2016, an increase of $300,000 from the first quarter of 2016. The Asset Manager Affiliates did not return capital in excess of their tax basis earnings in the second quarter of 2016, compared with return capital of approximately $500,000 in the first quarter of 2016 and $1.1 million in the second quarter of 2015.
Company recorded net realized and unrealized depreciation of approximately $2 million or $0.05 per basic share during the quarter ended June 30, 2016, primarily attributable to our investment in our Asset Manager Affiliates as compared to net realized and unrealized depreciation of approximately $11.6 million or $0.31 per share in the first quarter of 2016 and net realized and unrealized appreciation of approximately $4.6 million or $0.12 per share in the second quarter of 2015.
On the liability side of our balance sheet, as of June 30, 2016, the par value of our debt outstanding was $186.4 million consisting of $39 million of senior notes due in October of 2019, with a fixed rate of 7.375% and $147.4 million on our balance sheet debt securitization -- of our on-balance sheet debt securitization financing transactions which has a stated rate that resets quarterly. In the previous quarter, we had convertible notes matured which were repaid on March 15, 2016. Our asset coverage ratio at quarter-end was 205%, above the minimum required of 200% for BDCs. For additional information, regarding the above metrics for the second quarter 2016 result please refer to our earnings release and our recently filed 10-Q. All of our filings are available online with the SEC at sec.gov or on our website at kcapfinancial.com.
We would now like to turn it over to you for your questions.
[Operator Instructions]. Our first question is from Andy Ellner of JMP Securities. Your line is open.
Good morning guys.
Dayl I was hoping you could provide a bit more color on your view of the CLO market, and your ability to close the CLO this year given that CLO spreads have rallied and issuance has picked up?
Yes, I think that’s a great point Andy. CLO market as I mentioned it’s improved dramatically since its lows and sort of February, early March of the first quarter. Spreads on AAAs have come in probably by 15 to 20 basis points, was very difficult to market a deal in the fourth quarter, first quarter and even second quarter. It continues to improve since the beginning of the third quarter and we obviously raising of a CLO is a private placement so I can’t really comment much on the status of what we’re doing other than to say that we did upsize the warehouse by adding some additional first loss which I think is a good indication of our thoughts of whether or not we think we get something done in the near future.
Great. Thank you. That’s it for me.
Thank you, Andy.
At this time, I’m showing no further questions. I’m sorry there is a question from the line of Troy Ward from Ares Management. Your line is open.
Great. Thank you. Hey Dayl, just a quick follow up on the last question regarding the CLOs. Can you speak a little bit to what potential changes the retention rules may make in your CLO ownership and your issuance from Trimaran?
Sure. I mean I think as with everybody, I think we have various solutions in place to deal with risk retention. I think part of the problem was actually dealing with risk retention as the final rules have still not been written. So I think people are reluctant to lock into a specific structure and deals today. So I think when you’re in the market right now people are looking for a deal that is risk retention ready, not risk retention compliant and I think that as with market deals, we have the ability to make that assertion given the fact that we do have a structure in place to do risk retention which may or may not have to be changed once the final rules come out, assuming they come out this year. There’s been some speculation, we don’t assume this to be the case, there’s been some speculation that given that it’s already August, and no one’s put pen to paper yet that like a lot of other things, these risk retention guidelines may be pushed back, we’re assuming they are not going to be.
With the structure that you’re contemplating and have in place, does that imply any change in economics to KCAP on the ownership?
If there are changes, what we think it will be marginal but again, until we have sort of the final structure in place and the financing in place, it’s hard to comment beyond the fact that we don’t think it’s going to be a major change.
At this time, I’m showing no further questions. I would now like to turn the call back over to Dayl Pearson. Sir?
Thank you very much and thank you all for participating on the call and asking questions and we will be talking to you again in November unless something comes up in the meantime. Thank you very much. Take care.
Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program and you may all disconnect. Everyone have a great day.
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